by Rob Dix
That said, from everything I’ve heard from the experiences of other investors, there seems to be very little correlation between quality and price.
Where do you find a good broker? Recommendations are by far the best way – by which I mean recommendations from investors who operate the same kind of model that you want, rather than from your uncle who’s just remortgaged his own home. There’s also unbiased.co.uk which contains a directory of mortgage brokers (as well as financial advisers and other professions) along with ratings from their past clients.
Or of course, ask me. I know a few very good brokers, and while they’re unlikely to be based near where you live, that’s really not an issue: unless you’re the type of person who needs to look someone in the eye before you do business with them (in which case: FaceTime?), everything can be done perfectly well over the phone and email.
Quick note: when buying through an estate agent, you’ll sometimes be put under pressure to use their in-house broker. Occasionally you might even be told that they’ll only put your offer forward if you speak to their broker first. This is because it generates extra income for the branch (at the low end of the market, this can sometimes be more than the fee they’ll get for selling the property), and also partially because they’re used to having their time wasted with offers from people who it turns out can’t get finance.
If you don’t want to do so, don’t be afraid to say no: they must pass on your offer to the vendor whatever the circumstances, and a confident “I have my own broker who I always use” is usually enough to shut the conversation down. Even better, get a broker to arrange a “decision in principle” for you (a quick automated check from a lender that you’ll be suitable to borrow once you’ve found a property) to give the agent confidence that you’ve got your act together and are ready to proceed.
Flips and auction purchases
Although mortgages are the most common way to finance property investments, there are some situations where they’re not an appropriate tool for the job. Two of the most common situations are buying at auction, and “flipping” (also known as “trading” and “buying to sell” – which all refer to buying with the intention of selling for profit as soon as possible, without renting it out first.).
Mortgages aren’t suitable for auction purchases because you can’t guarantee that they’ll be arranged quickly enough. Once the hammer falls you normally have 28 days to complete the purchase – which can be enough time to arrange a mortgage, but only if everything goes in your favour. As you can’t start the process until after the auction (because you don’t know for sure what you’ll be buying), it’s a very tall order.
One way in which you can use a mortgage for auction purposes would be if you were planning to use the equity in your own home to fund the purchase. In this scenario you could go through the whole process of arranging the remortgage of your own home in advance, after which you normally get a window of three to six months before you have to “draw down” the funds. You therefore get the security of knowing that the funds are in place, without having to actually get the cash and start making the repayments until you’ve secured the property you want. That’s going to be a niche situation, but worth mentioning because it’s a nice option if it applies to you.
There’s a different reason why mortgages aren’t suitable for flips: they’re meant to be a long-term form of finance, and mortgage lenders don’t like you taking their money for just a few months. While it’s possible to get a mortgage with no early redemption penalty and just pay the whole lot back (say) six months after you take it out, and it’s also possible that you’ll get away with it a few times, eventually someone will notice and see that you’re (in their opinion) abusing what’s supposed to be a long-term product. As lenders share information between them, you could end up being blacklisted by multiple lenders – and struggle to get any kind of mortgage in future.
So if mortgages aren’t the right tool for the job in these situations, what is? Well, you only have two real choices: cash, or bridging finance.
Cash is self-explanatory, and the great benefit is that it’s free apart from the “opportunity cost” of having the funds tied up and not earning a profit elsewhere. For auction purchases that you intend to keep for the long term, you can buy with cash, then remortgage (coming up in the next section) in the future to pull some of your funds back out.
Bridging finance is short-term lending (lasting usually six to 12 months), which carries a higher interest rate than a mortgage but is much quicker to arrange. As a rough rule of thumb, you can normally borrow up to 70% of the property’s value.
It’s quicker because a bridging lender really doesn’t care about you (other than basic checks that you are who you say you are, and haven’t been declared bankrupt): their security is the property you’re buying. As a result, a bridging loan can be arranged start-to-finish within a week (whereas it can take months for a mortgage to go through).
Another advantage of bridging when it comes to flips and auctions is that they’ll lend against properties that would be considered “unmortgageable”. Broadly speaking, you can only get a mortgage on properties that could be lived in at the point of taking out the loan: they might not be luxurious, but they need to have a functioning kitchen and bathroom and be structurally sound. Bridging lenders don’t care: sure, the value of the property might be reduced if it’s a total uninhabitable wreck, but they’ll lend against whatever its value is all the same.
You’ll be able to see why this is particularly handy for flips (where you might want to buy a wreck, fix it up and sell it on) and auction purchases to either flip or keep (because properties often end up in auction in the first place because there’s a problem that renders them unmortgageable).
I said that it carries a higher interest rate than a mortgage, and that interest rate is usually in the range of 0.75%–1.5% per month. On top of that you can add an arrangement fee of 1–2%, a valuation fee, their legal fees, and a grab-bag of other “because we can” fees. (My favourite, which made me laugh semi-hysterically before suddenly getting very sad the first time it was charged to me, being a “repayment administration fee”. Yes, they charge you for their effort in receiving their money back at the end.)
Bridging, then, can look expensive by the time you’ve factored everything in. But if cash and mortgages aren’t an option and it allows you to do a deal that’s ultimately going to make you a lot of money, is it really expensive? Just factor the costs into your projections and see if it still stacks up. Be aware, though, that you need to be very confident that you’ll be able to exit the bridge at the end of the term by either refinancing or selling – otherwise they’ll crank up the interest rate or could even repossess.
There are a couple of nice tricks you can use with bridging finance too. Firstly, some bridging companies will lend against the property’s value rather than the purchase price – which means that if you do some amazing negotiation and secure a property for £70,000 when it’s genuinely worth £100,000, then the loan will be 70% of £100,000 and you won’t have to put any of your own money in (except for fees, refurb costs, etc.) This would never happen with a mortgage, as mortgage loans are always based on the lower of the value or the purchase price.
The other trick comes into play if you have no mortgage (or a very low mortgage) on your own home or another property you own. In this case you could get a bridging loan that takes security against the property you’re buying and your other property, which again means you can effectively borrow the whole purchase price. You could even borrow enough to cover your refurb fees and costs, too – thus putting none of your own money in. The downside is that your bridging costs would obviously be higher as a result, which would need to be factored into your calculations. And, of course, your home is at risk if the deal goes wrong for some reason.
Remortgaging
Remortgaging is something you might end up doing for any number of reasons. Some of the most common are:
You want to let out a house that you’ve lived in yourself up until now. You will need to switch from a residential mortgage to a buy-to-let mortgage.
You bought a property with cash or bridging, and now you want to move it onto a long-term mortgage to release your cash or get off an expensive bridge onto a cheaper form of finance. (Somewhat confusingly, it’s known as “remortgaging” even when you initially bought with cash and are therefore taking out a mortgage for the first time.)
You’ve had a mortgage product for a few years and the fixed rate has come to an end. Lower interest rates are now available elsewhere if you switch.
The value of your property has increased over time (either because of work you’ve done or just the market moving upwards), meaning you can borrow more money while still staying inside the maximum loan-to-value. This allows you to release funds to invest elsewhere.
You need to use a solicitor for any remortgage transaction, who will take care of the mechanics of adding and removing legal charges and repaying the previous lender (if there is one). I’m often asked how remortgaging actually works in practice, and that’s the answer: you’ll agree a loan with the new lender, your solicitor will receive the money and use it to pay back the old lender, and any balance left over is deposited in your bank account.
Just as would happen if you were taking out a loan against a property for the first time, in a remortgage scenario the lender will want to conduct a valuation, see the tenancy agreement if there is one, check that any work that’s been carried out meets regulations, and so on. But as far as anything involving solicitors and large amounts of money can be, the process is relatively painless.
With the mechanics out of the way, we can now take a more detailed look at each of the situations I outlined earlier.
1. You want to let out a property that you’ve previously lived in yourself.
At this point it’s worth reiterating that YES, you do need to switch from a residential to a buy-to-let mortgage if you’re no longer living there, and NO, it’s not true that “the lender doesn’t care as long as they’re getting paid every month”. It might be the case that they don’t notice right away, but when they do notice (and they’re in the habit of checking the electoral roll, for example), bad things will happen. It’s a breach of your mortgage terms, and they’d be within their rights to demand immediate repayment in full.
The only exception is if your lender agrees to give “consent to let”. This means that you stay on the same mortgage, but they agree that you can let the property out for a period of time – an arrangement that’s designed for people who need to move away for work for a while, for example. As is a common theme, the specifics depend on the lender: some won’t give consent to let at all, the ones that will all allow different periods of time, and some will increase the interest rate you have to pay while others won’t. In almost all cases there’ll be some kind of admin fee to pay.
If you’re remortgaging from residential to buy-to-let (rather than getting consent to let), potential lenders will assess it just like any other buy-to-let loan: they’ll conduct a valuation and offer up to a certain loan-to-value, and will also assess the rental valuation and insist that the rental income covers the mortgage by a certain amount (commonly 125%).
There are clearly pitfalls here: as residential mortgages can be offered up to 90% loan-to-value while buy-to-let seldom goes above 80%, you might not have enough equity in your property to switch. Also, if you live in a relatively large or expensive house, you might find that the rent you could achieve wouldn’t cover the mortgage payments by 125%.
2. You want to move from cash or bridging onto a mortgage.
This could come about in situations where:
You bought at auction, and therefore didn’t have time to arrange a mortgage.
You bought a property that needed so much work doing to it that it wasn’t mortgageable, and have now fully refurbished it.
You were able to secure a great price by moving quickly, again not allowing time to arrange a mortgage.
In these situations you might want to refinance straight away (to free up your cash or escape an expensive bridging arrangement), but there’s an obstacle to contend with called “the six-month rule”.
This is actually a guideline rather than a rule, but it’s enforced by the majority of lenders. It states that you must have owned a property for six months before you can apply to remortgage it. What this means is that if you buy a property with cash or bridging for whatever reason, you need to budget for having your cash tied up or your bridging repayments running for at least six months – actually longer, because you can only apply after six months of ownership and it might take another month or two for the mortgage to be arranged.
Not all lenders enforce the guideline (especially those termed as “commercial” lenders, who finance HMOs and developments), but most do – so it’s always a smart move to have six to eight months in your mind as the minimum period before you can remortgage.
3. You’ve had a mortgage product for a few years and the fixed rate has come to an end. Lower interest rates are now available elsewhere if you switch.
Mortgage products often come with preferential rates for the first few years, after which they revert to the lender’s “standard variable rate” (SVR). For example, you might get a two-year fixed-rate mortgage with a rate of 3.49%, and at the end of the two years it reverts to an SVR of 4.99%.
That means there are two reasons to move away: you’ll be able to secure a lower rate by switching to another lender and benefiting from their tempting “introductory” rate for a couple of years, and you’ll be able to fix your rate again if you want to. Standard variable rates are (obviously) variable and can change whenever the base rate changes or the lender just feels like it, whereas fixed rates give you certainty over your outgoings during that period.
While it’s tempting to just hop from mortgage to mortgage every couple of years to get the best rate, don’t forget to factor in fees. Every time you switch there’ll be legal fees, valuation fees, an arrangement fee (usually added to the loan balance but still very much a real cost), broker fees and so on. Shaving 1% off your interest rate and saving £50 per month might sound great, but it’s not a smart business decision if it costs you £2,000 in fees and you’ll need to do it again in a couple of years.
Once again, this is where a good broker will come into their own in terms of advising you of your options and whether it’s worth your while switching.
4. The value of your property has increased over time (either because of work you’ve done or just the market moving upwards), meaning that you can borrow more money while still staying inside the maximum loan-to-value. This allows you to release funds to invest elsewhere.
Many an impressively sized portfolio has been built on this basis over the last 20 years: buy a property with a 75% mortgage, wait for its value to go up, remortgage to 75% of its new value and use the cash you’ve released to buy another property.
This sounds great, and it is – but it’s crucial to consider the impact that refinancing will have on your cashflow.
For example, let’s say you bought a property for £100,000 with a 75% mortgage and have seen its value rise to £150,000. You can now remortgage to 75% of £150,000, which is £112,500. That means you can repay your original mortgage, repay yourself your deposit of £25,000, and have £12,500 left over to put towards a deposit somewhere else!
Sounds great, but remember that even though your loan-to-value is still 75%, you’re actually borrowing more money. So with an interest rate of 5%, your (interest-only) monthly payments would originally have been £312.50 and have now increased to £468.75.
If the monthly rent is £800 then that’s not necessarily an issue, but what if it’s only £600? By the time you’ve made the higher repayment and met all your other costs, your cashflow could be almost nothing (or less than nothing) – especially in certain tax situations which we’ll come to in the “Tax and accounting” s
ection. And if the rent is only £500, you wouldn’t be able to refinance in the first place because you wouldn’t have 125% rental cover.
This is a really, really (really) important point: remortgaging is great, but you’ve got to strike a balance between releasing equity and maintaining cashflow. There’s absolutely no point borrowing as much as you can to buy loads of properties if you end up barely breaking even or making a (pre- or post-tax) loss: yes you could end up making a capital gain on all your properties if the market is kind to you, but you’ve put yourself in a very vulnerable position.
In short, it’s all about balance. Remortgaging is a powerful tool, so use it responsibly and consider cashflow above everything else.
Chapter 7
Deciding where to buy
A major source of stress for aspiring property investors is coming to a decision about where to focus their efforts – both in terms of location, and what to buy within that location. Even if you’re dead set on operating within a half-hour drive of home so that you can easily self-manage your portfolio, that radius is still going to include areas with a whole range of demographics and housing types. And if you’re not limited to staying near home… well, then “analysis paralysis” can really set in.
It’s quite right to put considerable thought into this decision, because – as we saw in Part 1 – different locations and property types are suited to different strategies and outcomes. But don’t drive yourself crazy: while it does matter, it’s important to know when to stop pondering and start investing.
The key is to let go of the idea of finding the absolute best investment area in the country. New investors from analytical backgrounds often want to build some kind of uber-algorithm that feeds in thousands of data points and spits out the #1 investment that’s going to explode over the next decade… but I just don’t think it’s possible, or indeed necessary.