Buy-To-Let Mortgages

If you've decided that you want to buy an investment property then how do you finance it?

Rising house prices have meant homeowners who have been on the property ladder for some time will have spare equity in their homes. Many have, therefore, remortgaged their own homes to release enough equity to raise the required deposit for a buy-to-let (BTL) property.

The rest of the purchase price is usually financed with a BTL mortgage and with good reason -- there are tax advantages because BTL is considered a business venture and so you are allowed to offset the mortgage interest payments against any tax you might be liable for on the rental income. Bear in mind that this tax benefit only applies to the interest and not to any repayment of the capital.

Most lenders now offer a range of BTL mortgages. Indeed the number of BTL mortgages in existence has grown sixfold to 700,000 over the last five years. The points to consider are pretty similar to those you make when choosing your mortgage to buy your own home.

Repayment or Interest-Only

First of all, you need to decide whether you want to end the mortgage term with a fully paid-for property or not. If you have made no arrangements to pay off the mortgage capital (either through a repayment mortgage or a separate investment vehicle) then you may have to sell the property so you can pay it off.

It also depends on what you want from the rental income throughout the mortgage term. If you need some of the rent to live on immediately then an interest-only mortgage would probably be more appropriate because, after making the interest payments, there would be some rent left over for your own pocket. If you don't need the rent for yourself, then all of it can be used towards the interest payments with the surplus being used for the repayment of the capital or, indeed, to help finance a further BTL investment.

Remember you also need to keep some cash spare to cover void periods and repairs to the property. And, don't forget tenants who fail to pay their rent too - not only does it mean you're subsidising their housing when they don't pay up but it's an expensive business to have them evicted from your property.

So the advantage of a repayment mortgage is that the property will be all yours when you come to end of the mortgage term. The risk is that you will have less money to play with should you need some of the rent for other purposes and it's also not as tax-efficient.

The advantage of an interest-only mortgage is that your monthly payments will be lower so more of the rental income should be available to you - and you don't need to worry about the capital repayment until the end of the term. The risk is that, if you haven't made other arrangements, you'll have to sell the property eventually to pay off the original loan.

Bear in mind that you can get flexible buy-to-let mortgages which enable you to enjoy an element of both the repayment and interest only mortgages. Access to cash is immediate in an emergency and, if you don't need to get at it, any surplus can be used to repay the capital in the meantime. These are, however, slightly more expensive and you need to be very disciplined about how you manage your account.

Type of Interest Rate

As with any mortgage, you need to consider what sort of certainty you want regarding the interest rate. A BTL property is a long-term commitment and you are not only subject to the vagaries of bad tenants, voids and repair costs but also the state of the economy as a whole. If the Bank of England decides to put up interest rates you'll have to find more money to pay the mortgage and you can't always just put the rent up willy-nilly.

Variable Rate

This could leave you scratching around to meet the mortgage if rates go up but you will have more flexibility with your mortgage. The downside is that they're usually more expensive than most other types of rate and you won't have certainty about how much your mortgage payments will be.

Fixed Rate

This sort of rate does exactly what it says on the tin. The rate is fixed for a certain period of time - usually one to five years - and you'll know precisely what you have to pay each month. The disadvantage is that you may have redemption penalties to pay if you want to get out before the set period is up and you might even find yourself committed for a year or two afterwards.

Capped Rate

This puts a ceiling on the maximum you'll have to pay. If rates go down you'll benefit if they're below the cap and if they go up you'll never have to pay more than the cap. Again the disadvantage is the lack of flexibility if you want to change your mind during the set period because there are usually redemption penalties to consider.

Discounted Rate

A temporary reduction in the variable rate is often the cheapest type of interest rate if the discount is sizeable enough. But you'll likely be tied in during and after the term of the discount.

Your choice of mortgage for your BTL investment is just as important as the one you would choose for your own home -- perhaps even more so as you have the liabilities that come with renting to a tenant. You may be able to live with tatty carpets and tired paintwork but your tenant probably won't unless the rent is very cheap. And you need to make sure you can still make the repayments during void periods and when the tenant fails to pay up. So maintain an emergency fund look for flexibility in your mortgage as well as a decent interest rate.

Finally, don't forget that just as you can remortgage your own property, you can remortgage a buy-to-let property as well. Read our remortgaging guide for more details.