What are buy to let mortgages?

How do buy to let mortgages work, and will the right mortgage mean property investment is right for you?

Rent rises edge above inflation

Investing in property is back in fashion. It's hardly a major surprise. Soaring rents and solid price rises in many areas of the country have lifted the average return to 12.7% a year (when you take the rent and the growth in the house price into consideration). This is startling compared to many other forms of investment at the moment. You have to subtract the tax, mortgage repayments and maintenance costs from this, but for some people, it is still proving a very attractive prospect.

Unless you have hundreds of thousands of pounds burning a hole in your pocket, the most common way into this market is through a buy to let mortgage. These have been flying off the shelves too. In July, the value of buy to let loans was up 26% on lending the previous July. In that month £2.4 billion was lent to 17,500 buy to let investors. There are now 1.4 million private landlords across the UK.

However, before you can decide whether being a buy to let investor would suit you. It's worth understanding how these types of mortgage operate.

The costs
The mortgages work in the same way as standard mortgages - except that they tend to be a bit more expensive. The lenders charge a higher rate of interest, because they are taking a bigger risk in lending to you. In most cases investors rely on the rents their tenants pay to enable them to pay the mortgage. If they struggle to rent the property out - or the tenant fails to pay their rent - there's a risk that they will be unable to pay their mortgage.

In recent months these rates have fallen a bit - as lenders grow more confident that a rate rise isn't just around the corner. It's now possible to get a buy to let mortgage for less than 3%, a two year fix for less than 3.5%, a five year fix for under 4%, or a longer-term fix for less than 5%.

Unfortunately, the fees are also higher for this kind of mortgage, because lenders calculate that investors will be happier to pay more upfront in order to being down their monthly payments and make the monthly balance of cost and return more favourable.

The lenders also tend to expect a higher deposit. It gives the lender more security, because if you cannot pay your mortgage and they force you to sell up and repay it - the bigger deposit makes it less likely that any potential falls in the value of the property have left you in negative equity.

The fact that they are more expensive, may mean it's tempting to get a standard mortgage instead. However, this would mean committing mortgage fraud, and if you are caught doing that, you could have the mortgage withdrawn overnight.

The rules
In most cases, the lender will also require that you have a property of your own, and that you meet their threshold for minimum income. These things give them the security that you have other assets to call on if you don't have rental income with which to pay the mortgage. Some will stipulate a maximum age too - of between 70 and 90. This could throw a spanner in the works if you were planning to use buy to let income in retirement.

They may also have a minimum price of the property that they will lend against. This could be around £50,000 or £100,000 and is designed to keep problem properties off their books.

However, at the moment there is a bit of an anomaly in the rules, which means that buy to let mortgages are unregulated. It means that those who want to get this kind of mortgage don't have to go through the same kind of affordability checks as someone getting a mortgage on their own home.

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Of course, this doesn't make self-imposed affordability checks any less vital. It's essential that investors work out exactly what their will be spending each month on their property and their mortgage - and how that would change if interest rates rise, to make sure that the return would be high enough to be worthwhile.

You will need to factor in more than just the cost of the mortgage. There is also the tax on income, letting agency fees, maintenance, annual safety checks, rent insurance, or landlords insurance. You need to balance this against the rental income you will receive. It's a good idea to factor in some periods every year where the property is not let out - or where the tenants fail to pay their rent.

The only affordability check that most lenders carry out is to assess your rent as a percentage of your mortgage. They like your rent to be at least 125% of your mortgage payment - and the surveyor who does the mortgage valuation will be the one who decides what the rental value of the property is. If you are on a short-term mortgage they may not base this calculation on the mortgage cost while you are on the special deal - but on the rate it's going to revert to at the end of the two years.

The type of mortgage
It is possible to get repayment buy to let mortgages, but most of them are interest-only deals. The lender has the comfort that at the end of the mortgage period you can pay off the capital by selling up if needs be - unlike with a residential mortgage where this would leave you homeless.

This doesn't necessarily mean it's a good idea to rely on selling up in order to repay the debt - because in some cases you could end up in negative equity. You may also have to factor some sort of regular investment into your calculations - which would offset at least some of the mortgage debt when you reach the end of your mortgage term.

Some experts add that it is possible to buy properties where the asking price is low enough and the rent high enough for you to afford a repayment mortgage. So if you can afford one of these it's a good sign you have picked the right property. If you are struggling on the margins with an interest-only deal, it may be that you've not selected the best property to invest in.

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