by Rob Dix
Lenders use something they call “rental cover” to assess whether the investment is self-financing. Most buy-to-let lenders are regulated by the Bank of England’s Prudential Regulation Authority (PRA), who (as of January 2017) insist that the rent must cover at least 125% of the mortgage payment – assuming that the interest rate is at least 5.5%.
(This doesn’t apply to certain “specialist” lending such as bridging, commercial or semi-commercial property and holiday lets, nor to any lending with a fixed term of five years or longer. You also don’t have to worry about any of this if you’re re-mortgaging an existing property without increasing the debt, because that also escapes these rules.)
Example time! Let’s say you buy a £100,000 property with a mortgage of £75,000. Working from the notional interest rate of 5.5% (it doesn’t matter if your actual interest rate is lower: they’ll be making their calculations on the basis that it’s 5.5%), your monthly mortgage payment would be £343.75 (£75,000 multiplied by 0.055, divided by 12 to get the monthly amount). The lender would therefore want the monthly rental income to be at least £429.68 (£343.75 multiplied by 1.25) in order to give you the loan you asked for.
Different lenders vary in their criteria. While the regulations dictate that they need at least 125% rental cover, some lenders will go further and require 135% or 145%. Others will test more stringently in certain circumstances based on your tax position and other liabilities. I generally don’t pay too much attention to it. In my view, if you’re anywhere near having to worry about whether you have enough rental cover, the property will probably lose you money each month. After all, the mortgage is just one cost. In the example above, a rental income of £429 would satisfy the lender, but let’s imagine your actual rental income was £500: after paying the mortgage, you’d only have £71 to cover all other costs (maintenance, management fee, service charges, etc.) and leave you a profit. OK, in reality your interest rate might be lower than the notional 5.5%, but in any case it’s far too tight for me.
The PRA is insisting that another round of changes is brought in by September 2017. These changes will (among other things) establish tougher criteria for “portfolio landlords” – which they define as someone with four or more mortgaged properties. Generally speaking, the new criteria means that lenders must take into account income and liabilities across the investor’s entire portfolio rather than just look at the proposed new investment in isolation. It remains to be seen what effect this will have, but it certainly seems that portfolio landlords will have to jump through more hoops in order to secure a mortgage – and presumably the process will take longer (and perhaps even be more expensive) as a result.
What lenders want to know about you
That was the property. Now let’s talk about the other thing that lenders will be looking at: you.
As I’ve said, for buy-to-let mortgages, lenders won’t scrutinise every last KFC receipt like they tend to do for lending on your own home. The property is their main concern, but the number of mortgage options open to you will certainly depend on your personal circumstances.
There are hundreds of buy-to-let products available, and a good broker (a subject we’ll come to later) should be able to place you with something almost irrespective of your circumstances. However, you’ll have a wider selection of the market available to you – which will mean more choice, better rates, higher loan-to-value ratios, and so on – if your broker is able to tick certain boxes for you.
The first box to tick is having a non-property income of at least £25,000 – which can be a joint income if, for example, you and your spouse are buying the property together. While the amount they’ll lend is based on rent rather than a multiple of your income, most lenders want to see that you have some income so you’ll be able to service the debt if the property is empty for a period of time. Different lenders have different “minimum income” requirements, but £25,000 is fairly typical. They specify “non-property income” because, again, if your whole income comes from rents then there’s always the possibility that you’ll have multiple empty properties and be unable to pay.
This requirement can cause issues for freelancers or contractors, who find it harder to demonstrate their income than an employee who can just show payslips. Lenders typically want to see at least two years of accounts, but again, a good broker can look for exceptions to the rule.
The next box to tick is owning your own residential home. This is less to do with financial security (although it helps) than avoiding fraud: because buy-to-let lending criteria are more relaxed than residential, it’s not uncommon for people to get a buy-to-let mortgage on a property they actually want to live in themselves. Having your own home already reduces that risk in the eyes of the lender.
(And let’s be clear for a moment: using a buy-to-let loan on a property you want to live in, or getting a residential mortgage on a property you intend to let out, are both mortgage fraud and are seriously not a good idea – however many people tell you they’ve been doing it for years and “the lender doesn’t care as long as they get paid every month”.)
Another factor lenders will look at is whether you have property experience already – which, of course, doesn’t help when you’re brand new to property investment.
So if you’re starting out with no provable income, no home of your own and no investment properties… it’s going to be tough, but not impossible. If you do manage to find a lender who’ll accept you, the interest rate they offer you will be less competitive than normal because they need to price in the extra risk, and they might also offer you a lower loan-to-value ratio.
As time goes on and you become an “experienced landlord”, it does get easier… until it starts getting harder again, because many lenders will limit the number of properties you can have with them. While in theory you can have as many mortgages as you want, the reality is that some small lenders will reject you if you have more than a certain number of mortgages in total (or they’ll restrict the number you can have with them).
A specialist type of personal circumstance is being an expat – a status that makes life particularly tricky when it comes to mortgages, because most lenders want you to be resident in the UK.
More lenders are opening up to lending to expats than has been the case in recent years. Even so, the process can be lengthy, and fees tend to be higher because there’s so much more administration involved in verifying what you’ve told them and ruling out fraud. And as always, criteria vary: some will only lend to expats who are resident in certain countries or who work for recognised global employers, while others will require accounts to be certified by specific firms of accountants. The minimum loan size can also be higher for expats than UK residents, because mortgage companies want to lend a reasonably sized amount to justify the time put into processing the application.
So if you’re an expat, getting a mortgage is by no means impossible – but working with a specialist broker is definitely advisable, and healthy reserves of patience are preferable.
Finally, there’s the possibility that you’ll want to buy a property within a limited company rather than your own name, which is another factor that will reduce the number of options open to you. As a result of less choice, fees and rates will generally be higher – although as buying within companies becomes more popular, competition is increasing and costs are coming down. Even though the company is the buyer, the lender will make all the same checks on you (as the company director) as they would if you were buying in your own name, and will generally insist on a personal guarantee from you too.
What to look for in a mortgage product
As I’ll explain later, I’m pretty insistent about why you should use a broker (a really good broker, at that) to find your mortgage deal for you. But if you’re to validate what they come back to you with, it’s important to understand the factors affecting the attractiveness of different mortgage products.
The most obvious one is the amount they’ll lend you: the
loan-to-value. Historically it's been higher, but at the moment 80% is about as high as you can get (with the odd 85% out there), with the majority of products being at 75% and 60%. Of course, there’s no rule that says you have to take as much as the product allows: if you only want to borrow 40%, that’s fine.
The other big factor is the interest rate. This is a reflection of the risk the lender is taking on, which is a combination of factors around the property, you, and the amount of security they have. As a general rule, interest rates will be higher for 75% loans than 60% because the risk is higher.
The interest rate offered may be fixed or variable. Fixed rates range from two years up to as many as ten; their obvious advantage is that your monthly payment will remain the same for the entire time, so you can have certainty about what your biggest cost will be. Variable rates could just be the lender’s “standard variable rate”, which they can change whenever they fancy (although usually prompted by changes to the Bank of England base rate), or they could be a “tracker” rate, which moves precisely in line with either the Bank of England rate or the LIBOR rate. Variable rates introduce risk into your business model, but can work in your favour if rates fall: there are some very lucky people out there on “base rate minus 0.5%” trackers who've had years of paying zero interest.
Interest rates, however, are just one component of the cost you end up paying: loans also come with arrangement fees, which can either be a set amount (like £995) or a percentage of the total amount you want to borrow (often from 0.5% to 2%). There are also various valuation fees, account set-up fees and “because we feel like it” fees.
So as you can see, this isn’t just a matter of seeing who appears at the top of the “lowest rates” table and giving them a call: you need to first look at each lender’s criteria to see who will accept the circumstances surrounding you and the property, then think about how much you want to borrow and how long you want to fix for, then start comparing the various combinations of interest rates and fees to see which actually works out the cheapest over the lifetime of the loan.
And so far, I’ve been assuming that we’re looking at a bog-standard buy-to-let house rented out to a single working family. As soon as you deviate from that, a new world of complication opens up…
Financing "niche" investments
Just as the number of potential lenders reduces as you start to depart from their “ideal” client profile (homeowner, income above £25,000, experienced landlord…), you also start to have fewer options when the property you’re buying departs from the norm. Unfortunately, lenders’ definition of “the norm” is very narrow – and can exclude relatively common situations.
Two types of properties that lenders don’t like are flats above shops, and flats in a block of more than five storeys. The logic makes sense: high-rise flats tend not to be the most desirable, and there can be issues with flats above shops because you can’t control which type of business starts operating below you. And yet it’s common for swanky (and desirable) new blocks of flats to have six or seven storeys with retail on the ground floor. If you’re buying this type of property, it’s another reason why having a good broker is invaluable: they should have the relationships to make sure the property is judged on its merits rather than rejected out of hand (a flat in a brand new block of six storeys may not strictly meet criteria, but it’s a very different proposition from an ex-council tower block of 20 storeys).
Lenders can also be funny about renting to students, or people who receive housing benefit. This seems like a strange one to me because students can make for very secure tenants (you’ll normally have their rent covered by a guarantor), and any tenant could become reliant on housing benefit overnight if they lose their job. But nevertheless, it’s something to keep in mind.
And finally, there are multi-lets. Every lender will have a slightly different definition of what they’ll lend on: some will allow a certain number of unrelated occupants if they’re all on the same tenancy agreement, some will allow separate agreements but insist that bedroom doors don’t have key-operated locks, others will go up to a certain number of rooms but not beyond… it’s complicated. By the time you get into the realm of licensed HMOs with more than five bedrooms, you’re looking at a few specialist lenders only.
Again, it all comes down to the multiplication of factors: if you’re a first-time landlord wanting to get into large multi-lets, you’ll have few options because most of the specialist lenders want you to demonstrate property experience. If you start out with a simple buy-to-let, you’ll find it easier to get accepted by the specialist lenders in future because you’ll have experience.
Finding a great broker
You’ve now seen that getting a mortgage is a whole lot trickier than just choosing the lender with the lowest rate: what seems to be the lowest rate may not be by the time you’ve factored in other fees – and in any case, their criteria might be such that you (or the property you’re buying) might not be eligible anyway.
Every lender publishes their rates and criteria online, so there’s nothing to stop you from going through all of them and working out the best option for yourself – and indeed, I know people who do exactly this. Personally though, I can think of more enjoyable things to do with my time than comb through the small print of financial documents (clue: almost anything) – and it’s also worth bearing in mind that some lenders will only work through an intermediary (i.e. a broker or financial adviser), so you won’t have access to the whole market if you’re out on your own.
By having a broker on your team, you’ll also have someone to sense-check any potential investments before you go too far with them. For example, I recently spotted a property that I thought I might be able to buy quickly with cash then refinance later. I pinged an email to my broker, and ten minutes later she told me that (for a reason I’d never have thought of) it’d be impossible to get lending. None of my time was wasted, and I didn’t damage my relationship with the estate agent by making an offer that I’d have needed to withdraw later.
A final advantage of a broker – a really good broker – is that he or she will be in a position to keep your application on track when something weird and unexpected happens. And maybe it’s just me, but something weird or unexpected always seems to happen at some point during the process.
Take the last two mortgages I applied for: with one the lender freaked out because they somehow got the idea that the vendor was about to go bankrupt (he wasn’t), and with the other they thought I owed £29 to British Gas from a year ago and therefore wasn’t someone who they wanted to lend money to (I didn’t). In both cases, my broker was able to speak to an actual human, explain the facts, and get things back on track.
So for all these reasons, I’d always use a broker.
Not all brokers are as good as mine, but there are a fair few around if you look hard enough. So what does constitute a really good broker?
They have access to the whole of the market. A “whole of market” broker will scour every available lender to find you the most suitable product, which of course is exactly what you want. This is why it’s a truly terrible idea to walk into your high street bank and speak to the in-house broker there: they’ll only be able to offer you products from their own range, which will probably be inferior to other options that they’re not allowed to tell you about. Even outside of banks, some independent brokers are “tied” to offer only a limited range, so should be avoided.
They do the majority of their business in buy-to-let rather than residential. Buy-to-let is a totally different ball game from residential, and someone who only does a couple of buy-to-let cases each month isn’t going to have the same depth of experience as someone who does it day-in day-out.
They aren’t just a “processor”. Much like solicitors (which we’ll come to later), those brokers who work for big national companies often just process what they’re given without thinking about it too much – not because they’re daft, but because the business model
is set up to push through as many transactions as quickly as possible. You want someone who’s going to take the time to ask the right questions at the right time.
They have strong relationships. As I’ve explained, weird things happen – and when they happen, you want your broker to be able to fire off a quick email to their person on the inside and straighten it out. This is something you’d never be able to do on your own, so for me it’s one of the biggest strengths of using a broker.
They invest in property personally. A fellow investor will understand your priorities better than someone who only deals with investors in the abstract. They’ll be able to ask the right questions at the outset to determine your priorities, and match you with a product accordingly, because they’ve been through the same thought process many times themselves. It makes a huge difference to the quality of advice you get.
You’ll notice that I haven’t mentioned fees anywhere – and that’s because it just isn’t as important as everything I’ve mentioned. Getting the right advice could save you thousands of pounds over the life of a mortgage, so I’m not going to start quibbling over £100 here and there.
When a broker successfully arranges a loan for you, they’ll usually be paid a commission by the lender. Some brokers will charge you a fee too, while others won’t. My slight preference, oddly, is for brokers who charge me a fee – because it means they have less of an incentive to place me with the lender who pays them the biggest commission, rather than the one that’s best for my needs. It’s also the case, logically, that if they’re getting paid more per transaction, they’ll need to do fewer transactions to pay their bills and therefore will give me more time.