While the ‘official’ investment category is pretty new, the idea of buy-to-let property as an investment is not a new one. It seems like an easy investment opportunity, too- you put down as little as 20% of the property value, and the bank ‘pays’ for the rest, right? It’s not quite that easy, but it can be a lucrative investment for the right person. Let’s take a closer look.
What is buy-to-let property investment?
But-to-let property investment sees you purchase a house or a commercial property specifically to rent. Ordinarily, this would only be in the realms of the well-off, who could afford to put the full amount on the property down and then recoup their costs over time through rent. In the buy-to-let model, however, you take on mortgage debt in order to leverage it as a vehicle for income and capital growth too.
Property is generally seen as a good investment, as it’s almost guaranteed to increase in capital worth over time. Do note the ‘almost’. Property bubbles do burst, and property values and neighborhoods ebb and flow with time. If you sell at the wrong time, or worse, get stuck with a white elephant, you can lose everything you put in. It’s not a money machine, just another way to put money to work for you.
Taking on debt to finance investment is typically frowned on. However, a mortgage is one of the few types of debt that aren’t inherently damaging to carry, and in the right circumstances, this can be a smart way to leverage what you have, gain a capital-appreciating asset, and make an income too.
What is a buy to let mortgage?
Buy to let mortgages are a type of mortgage that can be used to finance the purchase of residential and commercial properties for investors.
Buy-to-let mortgages are very similar to regular mortgages, but there are some important differences.
- The fees are typically higher.
- Buy-to-let mortgage interest rates are often higher.
- The minimum deposit for a buy-to-let mortgage is often 25% of the property’s worth.
- Buy-to-let property mortgages are usually interest-only. You only pay the interest each month and not the capital. You pay back the original loan in full at the end of the mortgage period. Buy to let loans can also be obtained with a repayment plan.
How to get a buy to let mortgage
To qualify for a buy-to-let mortgage, you must meet certain eligibility criteria and be able to demonstrate your ability to repay the loan. The requirements will vary depending on where you live, but generally speaking, you need:
- A good credit history. You will need to show that you have been able to make repayments on other loans or debts that you have taken out previously.
- Deposit. This is the amount of money you have saved up upfront that will be used to purchase the property. As a rule of thumb it should be around 25% of the value of the property.
- The evidence of income or earnings from self-employment an important indicator used by most of the lenders.
- There is usually a maximum age limit for buy to let mortgages, which is usually between 75 and 80 years old.
- The monthly rental income you get or the average rents in the area determines how much you can borrow for a buy-to-let mortgage. Your rental income should be enough to pay off your mortgage in full.
Is buy to let property investment right for you?
Just as with any other investment type, the buy-to-let property isn’t a magic button to wealth, and it won’t be the right choice for everyone. It has a lot to offer, however, for the right investor. One of the key benefits of this investment type is that it produces a significant regular passive income, far more than most dividends can offer. While a lot of the rental amount needs to go to the mortgage on the property (vs a model where you already own the house outright before you let it) you might be able to make a rental yield of around 5-15% depending on the property and location. Before you rush to become a landlord, however, let’s look at some key factors.
1) Your financial position
The key difference between traditional property rental and buy-to-let property is that you take on mortgage debt to purchase the property. This means a significant portion of the rental income you earn is not ‘free money, as with a property you own that would stand vacant otherwise. So you need to be smart. What’s the local market-related rent in your area? Does it match up well with the cost of the property? What will you do if you can’t rent the property for a month or three- can you cover the cost? Market-related rent for equivalent properties is a must if you want to rent the property easily, so make sure it will cover your costs.
Another critical part of the equation is finding the lowest-cost finance to purchase the property you can. Often you want a home loan that understands the buy-to-let model. Or perhaps you have other equity you can leverage. Don’t forget that 100% bonds can be tough to get, and need an impeccable credit record and solid proof of income otherwise. So you might need to put down a deposit, especially if you use a buy-to-let home loan. This can be up to 20%, so be prepared. Most banks don’t care about the rental potential of the property- they want to see the means to pay it off in place already.
2) Worth to your portfolio
Realistically, buying a home to rent is may not always be a money factory You will have long-term upkeep costs, you will need to address problems your tenants bring to you.
Also there will be natural wear-and-tear, and you could face long periods where the property isn’t rented. It’s important that the rental yield you expect to receive is worth the hassle. Your yield is your annual rent value divided by the property value, as a percentage.
This is, of course, a gross yield. So you need to now factor in everything from insurance and mortgage to maintenance and beyond. Don’t forget a letting agent fee, if you’re using one, and taxes on the property. Deduct these costs from the gross yield to find your net yield. Only then can you properly evaluate if a buy-to-let property investment is right for you.
Remember that, while you are also acquiring an asset you can leverage in the future, that property is not always very liquid. You may need to wait a while for a sale, even once the house is fully paid off. So, in that sense, you won’t be able to withdraw your equity very quickly. If you are interested in a buy-to-rent property, view it as something like stocks, where you will need to leave the money there to appreciate for a decade or so before you can benefit from it. But, of course, there is the ‘dividend’ of your portion of the rental income to sweeten the deal.
Does the buy-to-rent investment model appeal to you? In the right hands, it can be a powerful way to earn income and grow capital all in one.
So it’s well worth considering as part of your portfolio.