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How to….buy-to-let mortgages

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Buy-to-let is no longer a route to riches, but if you still have the bug, here is what you need to know up front.

Buy-to-let has come under attack in recent years. It used to be seen as a smart route to quick riches, with investors using property market gains to remortgage to buy more properties, thereby creating a virtuous circle. Interest rates were low and the tax incentives were good.

Buy-to-let mortgages became far more difficult to obtain after the credit crisis. While the market has eased a little, the criteria are still tight. Equally, the tax incentives are not as attractive as the government has clamped down on rental profits.

Nevertheless, if you still have a taste for buy-to-let, here are some points you should know.

1. Buy-to-let mortgages don’t work in the same way as residential mortgages

Buy-to-let mortgages, for the most part, are not calculated on your salary, but on the income you are likely to receive from your rental property. Usually the rental income has to cover your mortgage by around 125%.

With interest rates low, this doesn’t sound particularly challenging. However, lenders do not calculate your mortgage based on your actual mortgage, but by using a ‘reversion rate’. This is usually 5-6%.

Like any other mortgage, the borrower must put up a deposit for the property and you will pay a higher interest rate the less capital you have in the property. Maximum loan to value rates are around 85%, but 75% would get you most of the better buy-to-let deals.

2. Interest-only is widely used

Unlike in the normal residential market, many buy-to-let mortgages are interest-only and lenders are usually happy to lend on that basis. This is because, unlike your main home, you can sell a buy-to-let property and still have somewhere to live.

Of course, you can still pay back the capital if you wish. The decision will depend on your long-term goals. If you plan to use it as an alternative pension income, for example, you might want to pay down the capital. If you are looking to leverage your capital to buy more properties, interest-only might be the better route.

3. You pay higher stamp duty

From April 2016, landlords have to pay an additional 3% stamp duty on property purchases. As stamp duty is now progressive, it makes little difference whether you buy one big property or lots of smaller properties.

4. There are plenty of other costs

While the top line sums can look attractive don’t forget to factor in elements such as maintenance, service charges and estate agent fees. These can really eat into your returns.

5. The income tax incentives aren’t as attractive as they once were

Buy-to-let mortgage interest relief is being axed progressively and will be replaced with a 20% tax credit by 2020. This will largely affect those paying higher rate tax, though it may push some basic rate tax payers into a higher tax bracket. If you have been letting for a while, you may have losses that you can carry forward and set against profits. You should also note that you will pay capital gains tax on buy-to-let properties.

Buy-to-let still has its merits, but it must be seen as a long-term investment and, with house price growth slowing, it is no longer a guaranteed route to riches. It is really important to do your maths, shop around for the best mortgage deal and make sure you snap up a bargain.

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