For many years the UK has had a very buoyant buy to let sector. While legislative changes over the last few years have dampened demand for buy to let funding in some areas, it is still a huge market. Data released by the Bank of England shows that overall gross mortgage advances during 2018 hit £72.9 billion which was up 5.5% on the previous year. The re-mortgage market accounted for 31.1% of mortgage advances (this would include an element of buy to let investors) with housing purchases accounting for 63.5%.
When breaking this figure down even further, we know that the buy to let investment market accounted for 12.5% of this figure which equates to around £9.1 billion. The fact that the figure of 12.5% was unchanged on the previous 12 months does to a certain degree reflect the short term challenges facing the buy to let market. We will now take a look at ways in which you can maximise buy to let mortgage funding and also consider the changes we have seen in recent times.
What are the major changes?
We have seen significant changes over the last few years and a number of these can be linked directly to the 2008 US mortgage crisis. This resulted in a worldwide financial crisis the likes of which has never been seen in living memory. Indeed many banks and financial institutions are still struggling to come to terms with the impact today. As a consequence, regulators and governments around the world began to encourage banks and investors to be more risk averse in the hope of avoiding a future repeat of the financial crisis.
- PRS (private rented sector)
The private rented sector is one which has seen significant change in recent times. The number of households in the UK private rented sector has increased from 2.8 million in 2007 up to 4.5 million in 2017. This significant increase in private rental investment, often taking up the slack left from social housing selloffs in the 80s, created significant income and profit for many private landlords. Unfortunately, as the UK government continues to battle funding challenges the sector became an easy target – a cash cow for the authorities. As a consequence, this led to an increase in stamp duty on second homes, reduced mortgage interest relief and more recently an expansion of tenant rights and powers when it comes to private rented accommodation.
- Buy to let income relief
In 2017 the UK government announced plans to gradually reduce the amount of mortgage interest deductible against rental income. While the deductions were replaced by a basic rate tax credit this is based on a 20% tax rate and will erode the benefits to higher rate taxpayers. The ongoing changes in buy to let mortgage income relief will be staggered as follows:-
Courtesy of: HMRC
On the surface there may seem little in the way of change but once you begin to dig deeper this sleight of hand by the UK government becomes apparent. If we consider the following scenarios:-
Rental income £20,000 per annum
Mortgage interest £10,000 per annum
Additional costs £2,000 per annum
Income after expenses £8,000 per annum
Under the current system the net income for a basic rate/ higher rate taxpayer would be £8000. This is the rental income less full mortgage interest relief and additional costs. The individual tax charges would be:-
Basic rate taxpayer:-
20% x £8,000 = £1,600
40% x £8000 = £3,200
If we look at the new system which is being brought in stage by stage, when it is fully implemented there will be no mortgage interest relief as such. This will be replaced by a standard 20% tax credit used to offset part of the mortgage interest. Under this new scenario, the same situation would see:-
Rental income £20,000 per annum
Additional costs £2,000 per annum
Income after expenses £18,000 per annum
(Before the standard 20% tax credit against mortgage interest)
As the profit calculation is based on £18,000 net rental income, not taking account of mortgage interest, this creates a larger liability for both basic rate taxpayers and higher rate taxpayers. This is before the 20% standard tax credit against mortgage relief. As you will see below:-
20% x £18,000 = £3,600
Less the 20% tax credit against mortgage interest = £2,000
Tax charge = £1,600
40% x £18,000 = £7,200
Less the 20% tax credit against mortgage interest = £2,000
Tax charge = £5,200
So in practice a 40% taxpayer will be £2000 a year worse off while a basic rate taxpayer would have the same tax liability under the new system as they had under the old one.
- Personal and company
In recent times there has been a growing suspicion that the UK government would prefer larger corporate landlords in the private rental sector. You could argue this suspicion has been proven with regards to the changes to mortgage interest relief, as highlighted above, for personal buy to let investments.
Even though the ability for individuals to fully deduct mortgage interest from rental income will be removed by the end of the tax year 2020/21 it is very different for companies. Mortgage interest will still be classified as a cost when looking at company expenses and profitability. As a consequence, we have seen many private landlords switching their buy to let investments into company vehicles. When taking into account additional charges associated with running a company, such as accountants, corporation tax, etc, these structures tend to be more relevant for larger buy to let investment portfolios.
- Regulated and unregulated buy to let
There are two specific types of buy to let funding which are described as regulated and unregulated. A regulated buy to let product, sometimes referred to as family buy to let, revolves around a property which will be:-
• Occupied by the borrower at some point
• Let to a family member
• See at least 40% of the building occupied by the owner (with the remainder let to 3rd parties)
There are many different situations where a borrower would use regulated buy to let mortgage products such as:-
• Expats acquiring property they intend to move to in the future
• Buying accommodation for children going to university
• Providing accommodation for elderly/sick family members/relatives
The description regarding unregulated buy to let products – often referred to as investment property loans – is fairly simple. These are mortgages available to landlords looking to buy property with the distinct intention of renting out to 3rd parties. The vast majority of buy to let funding in the UK is over the unregulated variety which can be provided by high street banks, private banks or niche lenders.
What are the defining features of a buy to let mortgage application – what moves the needle?
One of the keys to a buy to let mortgage application is presenting your income, finances and assets in the best possible light. In simple terms, the more security you can supply, in terms of income or assets, the greater the potential to agree terms. There are many specific issues which “move the needle” such as:-
- Rental cover
While some buy to let lenders will focus upon your non-buy to let income when assessing the affordability factor, others will take rent into consideration. This is obviously helpful but there can be fairly strict terms with regards to rental cover. Generally rental income would need to be in the region of 150% of monthly mortgage payments. If example your mortgage payments were £500 a month then at a 150% rental cover rate you would need to have rental income of £750 per month. We have seen circumstances where rental cover requirements have been significantly higher or lower than 150% – the level is determined by the specific circumstances of the applicant.
- Loan to value (LTV) ratio
The LTV ratio can vary dramatically between lenders although a 20% deposit and an 80% LTV ratio are certainly achievable. Some lenders may well work on a reduced LTV depending upon the specific circumstances of the applicant. Whether looking at traditional banks, private banks or niche lenders, the lower the LTV ratio the lower the headline mortgage interest rate. However, there is also the opportunity to achieve a higher LTV with some private banks and niche lenders which may take additional income/assets into consideration when calculating the affordability factor.
- Gross minimum income
When looking at traditional high street bank buy to let instruments you will no doubt come across the traditional £25,000 gross minimum income requirement. This is part of the affordability calculations carried out by high street banks although it is less relevant for private banks/niche lenders and for those looking at multi-million pound buy to let financing. If you are self-employed or a business owner then you will likely require additional paperwork to prove your income and show your financial situation in the best possible light.
As we touched on above, the greater the level of security you are able to offer against a buy to let mortgage/loan the more chance of securing finance. In simple terms, this gives lenders more headroom in the event of financial difficulties further down the line. They will simply be able to sell the security and use the proceeds to repay outstanding mortgage arrears. There is obviously a need to be sensible with security, and not overstretch your situation, but underutilised assets could significantly increase your mortgage payments. As ever, it all comes down to the risk reward ratio.
Rental income, affordability, charges and portfolio structures
When it comes to buy to let mortgages there are a number of options open such as traditional banks, private banks and niche lenders. Very often they have different ways of calculating affordability (there is a big difference in the way that high street banks and private banks/niche lenders are funded) and the way in which they treat rental income from a buy to let investment. There is also the option to switch buy to let assets into a company structure to address specific tax challenges. We will now take a look at the various scenarios:-
- Lender to lender
Initially many traditional banks looking to lend money to buy to let investors have strict minimum income requirements of £25,000 a year and they often discount the rental income on the buy to let property in question. The situation has changed a little in recent times although many banks still insist on the £25,000 a year minimum income. In relation to rental income, there is scope to take this into account using a calculation which is referred to as rental cover. The general tipping point for rental cover is around 150% which means that for a monthly mortgage of £500 the rental income on the property must be no less than £750 a month.
The situation regarding private banks and niche lenders is slightly different in that they will take into account worldwide assets and different income streams. Indeed, we have arranged mortgages in the past where the clients had zero regular income but significant asset security and rental cover. There is also the issue of assets under management which private banks tend to add to mortgage arrangements to widen their appeal to clients. When looking at bespoke buy to let funding, where there may be non-traditional finances involved, these tend to be the domain of private banks and niche lenders. In these situations much of the measurements and affordability factors are negotiable and every case is considered in isolation.
- Rate to rate – short term trackers to long term fixed
When looking at the array of different interest rates available in the buy to let mortgage market there is quite literally something for everybody. As UK base rates are currently near their historic low there is significant demand for short to medium term fixed rates. Some buy to let investors have even gone as far as to secure their mortgage rate beyond the traditional five-year period to give them clearer visibility going forward. At this moment in time it is difficult to say with any real confidence which way the UK economy will move in light of Brexit and how this will impact UK base rates.
We have also seen significant interest in tracker interest rates which track the path of base rates plus a fixed margin for the mortgage lender. This could be UK base rates +1.5% or something of a similar nature depending upon the lender’s financials and amount of money borrowed. We recently secured a European mortgage which tracked a European interest rate measurement which is currently negative. In this scenario the lender inserted a clause where the minimum European interest rate measurement was 0% (plus the margin on top). Who would have thought that short-term European interest rates would have tipped into negative territory?
- Client to client – effect of personal tax bracket
As we touched on above, the recent staggered change to mortgage interest relief is already starting to have an impact on higher rate taxpayers. The introduction of a new basic rate tax allowance ensures that basic rate taxpayers will see no difference in their end tax liability, although the calculation is different. Unfortunately, those in the higher tax bracket will not be able to offset all of their mortgage interest relief and as a consequence will pay significantly higher tax on their net rental income. There are high hopes that some of the recent private rental market regulatory changes introduced under Theresa May’s government could be cancelled in the event of a more right-wing leaning future Tory party leader. At the moment this is pure speculation but there is no doubt that higher rate taxpayers have suffered to a greater extent under the recent mortgage interest relief adjustments and new regulations. The recent changes have cast a very interesting light on the decision whether to hold buy to let assets in your own name or under a company umbrella.
- Individual or company owner
As we touched on above, there have been significant changes with regards to buy to let regulations as well as mortgage interest relief. On the surface, reducing the opportunity to offset genuine financial costs against income seems unfair. It has however prompted more buy to let investors to look towards the protection of a company umbrella under which the reduced ability to offset mortgage interest is not relevant. When looking at a company’s financial income and costs it is still perfectly legal to offset loan interest (mortgage interest) in full. As a consequence, higher rate taxpayers will no longer suffer the financial losses seen under the new system if the assets were held in their own name.
While for many people the option of switching their investments into a company is attractive, there are other aspects to take into consideration. In general, the cost of producing and presenting company accounts is an added charge compared to expenses if the assets were held in the clients own name. As a consequence, there will be a tipping point when the additional costs of running a company are offset by the tax savings compared to own name ownership. This is an area in which we can assist and arrange the appropriate advice for a client’s specific situation.
- Property portfolio size
In theory managing a portfolio of buy to let properties should be relatively simple, assuming everything goes to plan. However, the majority of buy to let investors will at some point experience difficult tenants, late payments, legal costs, and perhaps more importantly time management challenges.
While each scenario is very different, as a property portfolio continues to increase in size this will present different challenges and time constraints along the way. In this scenario the thoughts of many private landlords will move towards appointing a property management company to look after their assets. While there will obviously be a management charge to take into account, we have seen many occasions where the ever-growing size of a property portfolio simply becomes too much for one person to administer. As the regulations continue to tighten, often impacting profit margins, mistakes can be extremely expensive and place significant pressure on cash flow.
When, or even if, you should consider appointing a property management company will also depend upon the experience of the individuals involved. Remember, if your particular skills set is identifying properties to acquire then it may be sensible to focus on your strengths and employ the skills of third parties to manage your assets.
- Mortgage size
Here at Enness the vast majority of our clients are high net worth individuals often looking at multi-million pound mortgages. While the majority of these funding requests are more appropriate for private banks and niche lenders, often as a consequence of their greater flexibility, there are some traditional banks which are still competitive in this area of the market.
Traditional banks tend to look at more vanilla type mortgage funding where there is sufficient regular income to cover mortgage repayments. This is fairly straightforward and abides by the new affordability calculations introduced by regulators. As a consequence of our long-term relationships with many traditional banks, there is a greater degree of flexibility when instigating face-to-face negotiations. So, while the majority of multi-million pound mortgages tend to be the domain of private banks and niche lenders, this is not always the case.
Private banks and niche lenders tend to be more flexible and take into account global assets and multiple income streams. We also find that the majority of private banks prefer to incorporate a degree of assets under management into any financing when dealing with high net worth individuals. This allows them to offer an extremely attractive headline mortgage interest rate in the hope of expanding their relationship with the client and attracting additional assets under management further down the line. The majority of private banks/niche lenders tend not to openly publicise their services and as a consequence many still remain “invitation only”. This is where our independent status is invaluable allowing us to talk with in excess of 300 lenders from traditional banks to private banks/niche lenders.
The greater flexibility offered by private banks and niche lenders also allows high net worth individuals to maximise their additional assets as security. In simple terms, the more secure the lending arrangement the more attractive the headline mortgage interest rate. When you remove the various elements and strip mortgage funding back to basics, it is simply a case of calculating the risk/reward ratio and arriving at the appropriate mortgage interest rate.
Who are the main buy to let lenders?
The UK mortgage market is the most liquid in Europe and one of the more prominent around the world. However, since the 2008 US mortgage crisis many high street/traditional banks have taken a step back with regards to their risk profile. Over the last decade this has created something of a vacuum which private banks/specialist lenders have been more than happy to fill. However, high street banks still have a presence in the UK mortgage market and where there is an existing relationship there may well be scope for negotiation.
- High street
High street banks in the UK are funded very differently to their private bank/niche lender counterparts. As a consequence they have experienced a tightening of regulations and the introduction of affordability calculations to reduce the risk profile of the financial markets going forward. There is a degree of flexibility for bespoke arrangements but in some cases there are restrictions on how far the high street banks can go.
Specialist lenders are a vital part of the UK mortgage market, often offering those with non-traditional finances the opportunity to secure mortgage funding. As with their private bank counterparts, they tend to take a more rounded approach when it comes to multiple income streams and global assets. Many will also take a different approach to international finance requests – some of which may cause issues with other lenders. Despite the specialised nature of these groups, they will still accommodate vanilla mortgage funding applications.
- Private banks
Private banks have become the first port of call for many non-traditional mortgage funding applications. As we touched on above, private banks (and to a certain extent niche lenders in general) have filled the vacuum left by high street banks when they reduced their risk profile in the aftermath of the 2008 US mortgage crisis. The majority of private bank mortgage funding agreements tend to be of a bespoke nature therefore comparing headline interest rates with high street banks mortgages is often akin to comparing apples and pears.
Over the years private banks have become extremely popular with high net worth individuals who may also be looking for additional wealth management services. Very often you will see extremely attractive, often subsidised, headline mortgage interest rates used to tempt customers. Many mortgage arrangements will also involve the transfer of additional investments to the bank’s asset management division – a loose form of security.
- Bridging / short term lenders
We know from experience that many buy to let investors will acquire a property which may require renovations or an upgrade. As a consequence, bridging/short-term funding is often used to finance the cost of renovations/upgrades and then the property remortgaged on the higher value. Short-term finance of this nature can last anywhere between 24 hours up to 3 years although it tends to focus on short-term requirements – interest rates will reflect this. Historically we have often arranged remortgaging deals at the same time as bridging/short-term finance. This ensures repayment of the short-term finance as quickly as possible and re-bases the debt on a more traditional mortgage interest rate.
- Peer to peer / alternative options
The last few years has seen an explosion in property funding provided by peer-to-peer platforms (otherwise known as crowdfunding). While not always suitable for bespoke buy to let mortgage requirements, they do offer a viable alternative for vanilla funding requirements. The fact that the transaction is on a peer-to-peer basis effectively removes a layer of charges which is reflected in the overall cost. On the downside, peer-to-peer funding of property transactions offers limited regulatory protection at this moment in time. However, the European Union is currently undertaking a review of peer-to-peer lending with the intention of bringing in a new regulatory structure which will offer certainty and protection for all parties.
- International banks
In the aftermath of the 2008 US mortgage crisis, and resulting financial challenges, many international banks reviewed their risk profiles and decided to withdraw from various areas of the market. While cross-border financing of buy to let mortgages was one area which came under review there are still many banks willing to lend to expats and international investors. As with many high value mortgages the majority of deals available are not generally promoted to the wider public. This is where we are able to make full use of our numerous contacts in the market to arrange vanilla or bespoke buy to let mortgage funding.
It is also imperative that as a mortgage broker we are au fait with local market trends and preferences. For example, we know that many French banks prefer not to deal with expat/international investors. Participants in this market also prefer repayment mortgages ahead of interest only arrangements (which may be more preferable for a buy to let investor looking to maximise cash flow). It is these intricacies which ensure that we are able to negotiate and arrange the most competitive and appropriate buy to let mortgage deal structures.
As property portfolios continue to grow very often you will see special situations arise such as those listed below. Whether looking at rental income, property values or redevelopment, it is essential that you are aware of the best means to maximise buy to let lending and minimise costs.
- What to do if rental income doesn’t cover the mortgage – top slicing
Earlier in this article we highlighted the fact that those buy to let mortgage lenders who take into account rental income will have a set cover ratio. On average this works out at around 150% so for £1000 in monthly mortgage payments the lender would need to see £1500 in monthly rental income. There is a strategy which is known as “top slicing” which is used when there is a shortfall in rental income and the ratios (which vary from lender to lender) are not met.
In this scenario the lender will consider the client’s personal income and any potential surplus after taking into account various factors. Each lender will have a different calculation and way in which they consider surplus income. The idea is that part of this surplus income would be committed to the repayment of monthly mortgage liabilities – effectively covering the rental income shortfall. However, for larger portfolios there can be issues as the lender may need to recalculate affordability, taking into account top slicing, for all properties held by the individual.
- Large property portfolios
In recent times we have seen a number of private buy to let investors building up significant property portfolios valued in the tens of millions of pounds. One of the main benefits of such large portfolios is the significant cash flow and the use of paid-up properties for security/remortgaging opportunities. At this moment in time UK base rates are near their historic lows and as such there are some extremely attractive fixed rate mortgages available. As average rental yields are significantly higher than mortgage interest rates there is potential to maximise assets and increase income.
- Moving from personal name to company name
As we touched on above, recent changes in the mortgage interest relief system have already begun to hit higher rate taxpayers hard. This staggered approach to reducing the benefits for higher rate taxpayers has seen a number of private landlords looking to transfer assets into a company structure. On one hand this ensures that the costs associated with property investment loans can be fully offset against income, although on the other, on occasion it can be more expensive for companies to borrow money. There may also be capital gains tax considerations to take into account.
This is a scenario in which we excel, negotiating bespoke funding arrangements for personal and company assets which maximise income/assets while minimising interest rates.
- Letting current main residence when you buy another property
On numerous occasions we have come across clients looking to let their current main residence with the intention of buying another property. While it will depend upon the specific circumstances of each client, there are a number of factors to take into consideration. If you have an existing mortgage on a property you are wishing to switch to rental then you will need to inform your mortgage provider. There are legal and subtle differences between domestic mortgages and buy to let mortgages and lenders will take a different approach to this type of switch.
In the event that your current main residence is paid up in full, with no mortgage, this offers the option of remortgaging or simply taking out a mortgage on another property. Where there is no outstanding mortgage, future rental income could be used in tandem with regular income to increase borrowing potential for a mortgage on another property. It is certainly worth taking advice as how best to utilise the original property asset to minimise the interest rate on any new mortgage funding. There is also the issue of increased stamp duty on a second home purchases which may present the option to use a company structure to house one or more properties.
- Letting properties once you have redeveloped or built them
We covered the subject of bridging/short-term finance in one of the above sections and the fact this type of funding is very useful for redevelopment/new builds. The idea is simple; a property is acquired with investment funds/mortgage finance with the intention of redeveloping/building. The cost of redevelopment/building is financed by a bridging/short-term loan which is often structured in such a way as to stagger the release of payments when particular milestones are met. The staggering of payments ensures that the borrower does not pay interest on all funds for the full term, while obviously reducing the risk of the lender.
If for example we take a property worth £2 million and additional redevelopment/rebuild finance totalling £500,000, the total cost would be £2.5 million. If after the redevelopment/rebuild the property is worth £3.2 million then this has to all intents and purposes created additional value of £700,000. Once the redevelopment/rebuild is complete the property can be remortgaged on the higher value, utilising funds to pay off the original mortgage and the bridging/short-term finance. Any additional funds raised on the remortgage could be used for further investment or the mortgage LTV reduced (thereby reducing the headline interest rate) by retaining equity within the property.
- Letting very large properties – buy to let mortgages over £3m
The best way to maximise funding, and reduce headline interest rates, for large buy to let mortgages is to utilise all income streams and all assets. Traditional buy to let mortgages tend to require an initial deposit of around 25% of the property value. However, when looking towards private bank/niche lenders this is often negotiable and may sometimes involve the transfer of assets to the asset management division of the lender.
For vanilla type buy to let mortgages in excess of £3 million there may still be options available through traditional high street banks. We have extremely strong relations with many of the U.K.’s high street banks and therefore we are able to negotiate very competitive deals. Where the situation is a little more complicated, perhaps with multiple income streams and assets dotted around the globe, we tend to find that private banks and niche lenders are more flexible to creating bespoke arrangements. It really does depend upon the individual circumstances of each client, their current and future income, assets and plans for the future.
Traditionally, buy to let mortgages require deposits of around 25% although this can be higher or lower depending on the client’s circumstances. While some lending institutions will calculate the affordability using the client’s income others will take into account potential rental income. This brings into play the issue of rent cover which is usually a minimum of 150% although it can vary. This ensures that rental income is more than sufficient to cover regular mortgage payments and also factors in potential short-term non-occupancy of the property. A period of non-occupancy can significantly impact cash flow so this “headroom” offers a degree of security to lenders as well as the underlying investor.
We tend to find that larger buy to let mortgages often require a bespoke/specialist approach with a specific structure built around the client’s income, assets and overall financial situation. Even though many high street banks have taken a backward step from non-traditional buy to let mortgages, there are still opportunities to raise significant buy to let funds on the high street. There is no one size fits all when it comes to multi-million pound buy to let mortgages although thankfully we have the contacts and experience to create the optimum structure and negotiate the best rates.