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The idea of having a second property as an investment in later life is a tempting one. Property prices seem eternally on the rise and every year of pondering seems like a lost year of revenue, but is it all as easy as it seems?
The rise in property value – a major temptation
It doesn’t matter where you look across the UK, property value is on the rise. According to data available from the land registry, an average property in June 2009 cost £159,561 and today in 2019 stands at £228,903 – that’s an increase of 43.45%.
If that’s the only figure you ever look at then it’s obvious – investing in property is a brilliant idea.
Of course, that’s not the only figure you have to look at!
Buy-to-let mortgages – the interest only option
Most buy-to-let (BTL) mortgages are interest only. While repayment mortgages do exist on the market and we at Your Funding Expert can find those for you, interest-only is the landlord’s mortgage of choice and with its lower monthly payments, makes a lot of sense.
With an interest only mortgage, your monthly bill only covers the interest on the loan, keeping the balance steady throughout the term. At the end of the mortgage, you still owe the balance, which can be paid off (typically through the sale of the house), renegotiated and extended or repaid with a new mortgage.
Interest only keeps the monthly mortgage payments low, prevents the effect of compound interest, and still gives you the profit on the value of the house increasing at the end of the term.
As a simplified example, take a mortgage value of £100,000 at 5%; each year, this would accrue £5,000 in interest. Divided by 12, £5,000 is £416.67, thus that is the amount an interest only mortgage would cost per month.
The buy-to-let mortgage deposit
Like a repayment mortgage, a buy-to-let interest only mortgage would require a deposit, typically around 25%.
These deposits are higher than residential mortgages due to the extra risk the lender is taking (tenants are less secure payers than the mortgage holder living in the property), and also due to the simple fact that mortgage is part of an investment portfolio.
You would be expected to have this deposit available as capital, though if you are looking to grow a portfolio of properties, equity in another property could be used as a charge for a deposit on another.
Renting out the house
Every buy-to-let property plans to have tenants in. The mortgage lender would be looking for a market value rent of 125% the monthly mortgage costs in order to mitigate the risk and provide a safety net for the times when the property is unoccupied.
The rent must be set high enough to accomplish a few things, therefore:
- Cover the cost of the mortgage repayments
- Provide an additional amount to offset periods without occupancy
- Have enough remaining to cover all ongoing maintenance
- Pay any agent fees
- Provide profit for the house owner
Harold wants to try his hand at being a landlord on a buy-to-let property valued at £250,000. He must save a £62,500 deposit which he invests, asking the mortgage lender for a buy-to-let interest only mortgage for £187,500 which he gets at 4.8%.
Each monthly repayment on his mortgage will be £750; Harold needs an extra 25% of £187.50 to cover periods without tenants.
Harold estimates his monthly maintenance bill to average out at £150. He plans to let the property himself and not worry about agency fees, squeezing the remainder of the rent as profit for himself.
Harold sets the rent to £1,200 per month, giving him a profit of £112.50 per month.
After ten years, Harold plans to sell on the house and is hoping for an increase in value of at least 25%. If everything runs according to play, Harold will sell the house for £312,500. He will pay back the mortgage of £187,500, leaving him with £125,000. He has doubled his initial deposit investment of £62,500.
Additionally, Harold has made £112.50 per month, totalling an extra £13,500.
Harold’s total profits over ten years are £76,000.
Tax and work – why it’s never that simple
Buying and selling property comes with fees and taxes. Stamp Duty Land Tax (SDLT) on the original purchase of the property is £10,000 (this is calculated at the additional property rate of 3% on the first £125,000 and 5% rate on the remainder).
Valuation fee, surveyor costs and legal fees could be anywhere between £3,000 and £4,000. Plus, on the sale of the home, Harold could conceivably pay 3% of the house value, or £9,375.
Buildings and landlord insurance are also factors, approximating as much as £300 per year, or £3,000 in total.
Total additional costs could reduce Harold’s profit to a more unassuming £49,625 – 79.4% of his original financial investment.
Capital gains tax on property could conceivably take a further 28% or £13,895 from that final figure, leaving Harold with £35,730
In addition to the pure financial cost of the venture, Harold has also had to put in work. Assuming his tenants were always pleasant and didn’t put him out too much, Harold might have been able to manage his property for as little as one day’s work per month. That’s 12 days work a year, or 120 days work over the entire term.
Harold’s investment and work have netted him a little under £300 per day that he put into the venture.
*all figures used in this example are simplified for ease of understanding and while the information provided draws a fair and reasonable picture, it should not be considered a definitive guide.
Not an exact science – why the risk of buy-to-let is worthwhile
The example shown above still has many holes and assumptions in it. Perhaps Harold had an extended period without tenants meaning his backup money was used up or maybe he had great tenants who stayed the entire time and he never suffered a period without rent – meaning he’s up another £22,500! His repairs could have improved the value of the property beyond the 30% assumed, or a housing crash could have reduced his equity to zero.
The housing market is a risky prospect, house prices really do go down as well as up, and unforeseen problems can crop up. There are so many variables, it is quite impossible to track them all. Of course, if that wasn’t the case then the mortgage lenders and investors would simply own all the property themselves, capitalising on this new guaranteed investment.
Buy-to-let can reap significant rewards. In our example, the market only increased by 30% in ten years, but the real UK market increased by more than 43% in the same time. Harold’s buy-to-let mortgage was set at 4.8% but at The Mortgage Hut we’ve done deals for BTL mortgages closer to 2% than 5!
There’s no pretending that being a landlord is easy free money though. Like anything else that can make you money, it’s hard work. You must deal with tenants (often different ones as the years go by), fluctuations in the housing market, periods of worry and even the odd phone call disturbing you in the middle of the night – but it can be very rewarding. Especially if you get the right mortgage.
Give us a call today or simply fill out our contact form for a no-obligation quote – and we’ll find that right mortgage for you, kickstarting your own property portfolio without delay!
*Based on our research, the content contained in this article is accurate as of the most recent time of writing. Lender criteria and policies change regularly so speak to one of the advisors we work with to confirm the most accurate up to date information. The information on the site is not tailored advice to each individual reader, and as such does not constitute financial advice. All advisors working with us are fully qualified to provide mortgage advice and work only for firms who are authorised and regulated by the Financial Conduct Authority. They will offer any advice specific to you and your needs.
Some types of buy to let mortgages are not regulated by the FCA. Think carefully before securing other debts against your home. As a mortgage is secured against your home, it may be repossessed if you do not keep up with repayments on your mortgage. Equity released from your home will also be secured against it.