Are Buy-to-Let Mortgages More Expensive?

In short, yes, they are. The buy-to-let (BTL) market has long been a popular avenue for investors seeking to generate rental income and benefit from property value appreciation. This article explores various aspects of BTL investments, including why BTL mortgages might be considered more expensive.

Understanding BTL

What is BTL?

BTL refers to purchasing a property with the intention of renting it out to tenants rather than living in it yourself. This investment strategy allows landlords to earn rental income while potentially benefiting from long term capital growth if property values increase.

Key Considerations for BTL Investments

1. Financial Aspects

BTL mortgages:

Securing a BTL mortgage is a crucial step for investors if they are not buying the investment property entirely with upfront cash. BTL mortgages differ from standard residential mortgages in several ways:

Higher interest rates:

High inflation led to multiple increases in the Bank of England's base rate, resulting in average BTL mortgage rates reaching a peak of 6.79% in August 2023. After declining to 5.5% in February 2024, rates have edged up slightly, averaging 5.55% at the start of July 2024. This is significantly higher than the 4.31% recorded two years ago, meaning that landlords who are refixing after a two-year fixed term, for example, will face higher interest payments and those refixing after a five-year term even more so.

Larger deposits:

BTL mortgage lenders usually require a deposit of 25-40% of the property value, which is significantly higher than the 5-10% deposits that are sometimes sufficient for owner occupier residential mortgages​.

Interest-only payments:

Most BTL mortgages are interest-only, meaning landlords pay only the interest each month and repay the principal at the end of the loan term. This structure can result in lower monthly payments but requires careful planning for the final repayment​​. It also means overall higher interest payments over the life of the mortgage.

2. Taxation and Costs

Recent changes in tax legislation have impacted the profitability of BTL investments:

Mortgage interest tax relief:

Landlords can no longer deduct 100% of their mortgage interest expenses from their rental income to reduce their tax bill. Instead, they now receive a tax credit based on 20% of their mortgage interest payments at the 20% basic rate of income tax. This is less generous than the previous system, where higher rate taxpayers effectively received 40% tax relief on all of their mortgage interest payments. The new system has been phased in gradually since 2017​.

Stamp duty:

BTL properties attract an additional 3% stamp duty surcharge on top of standard rates, further increasing acquisition costs​.

Capital Gains Tax (CGT):

When selling a BTL property, landlords must pay CGT on the taxable capital gain. The annual CGT allowance has been reduced from £12,300 to £3,000 since 2022, meaning higher CGT liabilities upon sale​​.

Who Can Get a BTL Mortgage?

Obtaining a BTL mortgage requires meeting specific criteria set by lenders. Unlike residential mortgages, BTL loans are tailored for investment purposes and come with unique eligibility requirements:

Eligibility Criteria

Age:

Most lenders require borrowers to be at least 21 years old. Some lenders may set a higher minimum age, such as 25, particularly if the applicant is a first-time landlord​.

Income:

A minimum annual income is often required, typically around £25,000. This is to enable the borrower to cover the monthly mortgage payment from personal income if occasionally required​.

Credit History:

A good credit score is crucial. Lenders will scrutinize the borrower’s credit history to assess reliability. A poor credit history may disqualify applicants or lead to higher interest rates​.

Deposits:

BTL mortgages generally require larger deposits than residential mortgages. Most lenders ask for a minimum deposit of 25% of the property's value, though this can rise to 40% depending on the borrower's financial situation and the lender’s criteria​​.

Experience:

Many lenders prefer applicants who already have experience of owning and managing BTL properties, as this demonstrates the required knowledge and skill. However, some lenders are willing to consider first-time BTL landlords​.

Rental Income:

Lenders typically require that the expected gross monthly rental income covers 125% to 145% of the monthly mortgage payment. This is known as the Interest Coverage Ratio (ICR), which provides a buffer to ensure that mortgage payments can still be met even if the property is vacant or if other unexpected expenses arise​​.

Employment Status:

Both employed and self-employed individuals can apply for BTL mortgages. However, self-employed applicants may need to provide additional documentation, such as tax returns and business-related financial statements, to prove their income​​.

Affordability Stress Testing:

Lenders conduct stress tests to ensure that borrowers can afford the mortgage if interest rates rise. This typically involves assessing affordability at an interest rate 2 percentage points above the current rate.

Market Conditions and Location

The profitability of a BTL investment heavily depends on location and market conditions:

Rental yields:

Cities like Sunderland, Dundee and Glasgow currently offer higher rental yields, with some areas reaching up to 8%​.

Capital growth:

Long term capital growth has been significant for early investors. From 2000 to 2018, average property prices increased by 2.6% above inflation annually. However, recent forecasts suggest that this trend may not continue as strongly in the near future​​.

Rental demand:

Changes in rental demand can all impact property values and rental income. Investors need to stay informed about such factors to make strategic decisions​​.

Legal and Operational Considerations

Landlord responsibilities:

Legal obligations include ensuring the property is safe and habitable, conducting regular safety checks (e.g. gas safety and electrical safety), and adhering to regulations on fire safety and Energy Performance Certificates (EPCs)​​.

Tenant sourcing and tenancy management:

Investors must decide whether to manage the property themselves or engage a letting agent. Letting agents typically charge 10-12% of rental income for tenant sourcing, and an additional 6-8% for tenancy management​​.

Maintenance and repairs:

Landlords are responsible for ongoing maintenance and unexpected repairs. Regular upkeep is essential to preserve property value and ensure tenant satisfaction​.

Strategic Considerations

Investment horizon:

BTL investments should be viewed as long term commitments. Short term market fluctuations can affect profitability, but long term investments can benefit from both rental income and capital appreciation​.

Profitability and Challenges

Despite the higher costs and increased regulatory burden, BTL can still be profitable:

Rental income:

Rental yields, which refers to the income generated from renting out a property, can be a reliable source of income, particularly in locations where there is significant demand for rental properties and a shortage of available housing.

Capital growth:

Recent market trends indicate that while long term capital appreciation has the potential to significantly boost investment returns, future growth may be more subdued.

Tax-efficient strategies:

Investors can explore tax-efficient strategies, such as transferring properties to a limited company, to mitigate the impact of recent tax changes relating to mortgage interest deduction.

However, challenges remain:

Market volatility:

The value and demand for real estate can be influenced by a combination of economic and political factors, such as interest rates, employment trends, government policies and geopolitical events. To succeed in real estate, it is essential to stay vigilant, continually educate yourself about these factors and be prepared to adjust your strategies in response to the changing market conditions.

Regulatory burden:

Navigating legal obligations and maintaining positive tenant relationships can be a complex and resource-intensive process. Seeking professional guidance and support can significantly ease the burden of these tasks.

Conclusion

BTL mortgages are generally more expensive than standard residential mortgages. Despite this, BTL investments can still be an attractive venture with careful planning and strategic decision-making.  

Investors must consider the importance of location and market conditions, and legal and operational responsibilities, alongside a suitably long investment horizon, for managing risks effectively and maximizing returns.  

Whether you are a seasoned investor or considering entering the BTL market for the first time, it is important to conduct thorough research and consider seeking expert professional advice. With the right approach, BTL can still offer attractive returns and a valuable addition to your investment portfolio.

References

Buy-to-let mortgage interest tax relief explained | Which.co.uk | Published Apr 2024

The buy-to-let sector and financial stability | BoE | Published Dec 2023

Is buy-to-let still worth it? | Unbiased | Published Aug 2024