Buy-to-let (BTL) mortgages are for landlords who buy property specifically to rent out. They are usually more expensive than normal mortgages.
Buy-to-let mortgages are only suitable for people who want to invest in houses and flats. Investing in property is risky and you should be cautious when taking out a BTL mortgages if you cannot afford the risk. BTL mortgages are normally only available to existing home owners whether owned outright or with an outstanding mortgage. You must have a good credit record and not be too stretched on other financial commitments such as mortgage, credit cards and loans. Most lenders impose a minimum income requirement of £25,000 per annum.
Buy-to-let mortgages are similar to ordinary mortgages but with some key differences. Interest rates on buy-to-let mortgages tend to be higher. Most lenders who offer BTL mortgages impose a minimum deposit of 25% of the property’s value. The product fees are usually much higher. Most BTL mortgages are Interest Only, which means you do not pay anything of the capital borrowed. Unlike obtaining a mortgage on a property you wish to live in, BTL mortgage lending is currently not regulated by the Financial Conduct Authority (FCA) unless you wish to let the property to a close family member (e.g. spouse, child, grandparent, parent or sibling). This means that most BTL mortgages are unregulated.
The maximum you can borrow is linked to the amount of rental you expect to receive. Lenders typically need the rental income to (25 – 45%) higher than your mortgage payment.
It is really important not to assume that your property will always have tenants. There will almost certainly be “voids” when the property is unoccupied or if rent has not been paid. It is essential to have a financial cushion to draw on as when this may happen. You may also need additional funds for major repair bills, for example boiler breakdown or blocked drains.
If you sell your buy-to-let property for profit, you will pay Capital Gains Tax if your gain exceeds the annual Capital Gains Tax threshold. Rental income is also liable to Income Tax.
HELPING FUND BUSINESS, PROPERTY AND VEHICLE FINANCE
Five tax rules landlords need to know
1 Stamp duty on second properties
From April 2016, stamp duty land tax (SDLT) on second properties, including rental properties, was increased to include an additional 3% surcharge over and above standard rates.
This means anyone purchasing a rental property now pays 3% SDLT for the first £125,000; 5% instead of 2% on the portion between £125,001 and £250,000, and 8% on any amount above £250,001.
The change to SDLT increases the amount of up-front cash landlords need to buy a new property. As a result, implementation has been followed by a significant drop in new property purchases. According to UK Finance, the average number of buy-to-let mortgages taken out for house purchase each month in 2014 was 8,300. In 2017, this fell to 3,800.
2. Tax on rental income
Until recently, landlords could deduct all finance costs from their rental income and profits were taxed at their marginal rate.
However, starting from April 2017 and phased in over a four-year period, tax relief for finance costs is being restricted to a basic rate tax credit.
Exactly how the new rules impact landlord finances will depend very much on each landlord’s individual circumstances and portfolio. For basic rate taxpayers with small portfolios, the impact is likely to be limited. However, those with bigger incomes and larger portfolios are likely to see a significant change and some taxpayers will also move to a higher rate tax band.
Landlords are adopting a range of different strategies to mitigate the impact of these changes, ranging from rent increases to portfolio resizing. Moving properties into a limited company is one strategy often mooted but, while this may work for some, it will not be advantageous for all and landlords should take professional advice if considering this option.
3. Wear and tear allowance
Landlords with furnished properties can take advantage of a ‘wear and tear’ allowance to reflect the fact that furnishings need to be replaced regularly.
Until recently, the allowance was set at 10% of gross rent but, following a change to the rules, landlords can only deduct the cost of new items against their rental income now.
There is no deduction available for the initial furnishings and, to take advantage of this allowance, landlords will need to show evidence of the actual cost of replacing furnishings and make the claim in the year that the replacement was made.
4. Insurance premium tax
Landlords can expect to pay 12% insurance premium tax on any insurance they arrange associated with their rental property.
While there is no legal requirement for landlords to take out insurance, mortgage lenders usually require specialist building insurance to cover the costs of rebuilding or repairing the structure of the rental property if it is damaged or destroyed by events like fire, storm, flood or vandalism. Landlords may also decide to take additional insurance to cover, for example, damage to their furnishings and appliances, tenant default or home emergencies.
Insurance premium tax has been on the rise for almost all categories of insurance rising from 6% prior to November 2015 to 12% today.
5. Capital gains tax
Landlords are subject to capital gains tax (CGT) on property sales.
The size of the gain is usually the difference between the amount paid for the property and the amount achieved when the property is sold. Landlords can deduct costs associated with buying, selling and improving their property to reduce the gain so it’s important to keep receipts for all these items.
Basic rate taxpayers pay 18% on gains they make when selling property, while higher and additional rate taxpayers pay 28%. With other assets, the basic rate of CGT is 10% and the higher rate is 20%.
Landlords also need to be aware of a couple of planned changes to CGT around payment dates and relief.
Currently, CGT on property sales is payable on 31 January – after the end of the tax year in which the sale completes. However, for property sales made after 6 April 2020, it’s expected that payment will need to be made much quicker – 30 days after the sale completes. In addition, from this date, reliefs currently available if a property has previously been a principal private residence will reduce.
When residential properties are held in a company or other ‘wrapper’, additional regulations may also apply, including the Annual Tax on Enveloped Dwellings.
House in Multiple Occupation (HMO)
HMOs are becoming an increasingly popular option for investors. Higher rental yields are achievable and mortgages for such properties are more accessible in today’s market. New regulations to bring mandatory licensing to all multi-occupied properties where there are five or more people, forming two or more separate households.
The main changes are:
- Altered definition of an HMO under the Housing Act 2004: for licensing purposes, from 1/10, an HMO will be any property occupied by five or more people, forming two or more separate households.
- This contrasts with the existing HMO definition which is a property occupied by 5 or more people, forming two or more separate households and comprising three or more storeys.
- If you already have an HMO license under the current definition, this will continue to be valid until the license expiration date (usually 5 years from date of issue). After the expiration you will need to apply for a new license as usual.
- If you currently let an HMO which didn’t previously require licensing but will do after the new order comes into effect later in the year, then you will need to apply for a license through the local council.
- There is an important exception: if the property is in a purpose-built block of flats comprising 3 or more units
- Regulation 2 introduces minimum room standards for those properties falling within the scope of mandatory licensing.
The proposals will prohibit landlords from letting rooms to a single adult where the usable floor space is less than 6.51sqm and 10.22sqm for a room occupied by two adults. It will be mandatory for an HMO licence to include a condition that states the maximum number of persons who may occupy each specific room in a property as sleeping accommodation.
In breach of licence condition
Landlords will have to stop letting rooms that fall below the nationally prescribed standard. If they do not, then they will be in breach of licence condition and could be prosecuted by the local authority or alternatively receive a civil penalty under the new Housing and Planning Act 2016 provisions. Rooms below the prescribed standard that have previously been found suitable for occupation will no longer be capable of being let separately as sleeping accommodation by any person aged over 10 (4.64 for children under 10).
Rooms under 4.64sqm cannot be used for sleeping. Floor area under a height standard of 1.5m is not included in the calculation
Does my client’s property need a HMO Licence?
There are three types of licence applicable to HMO’s as defined in the Housing Act.
All large HMOs must be licensed by the local council. A property defined as a large HMO if all of the following apply:
- It is at least 3 storeys high.
- At least 5 tenants live in the property, forming more than 1 household.
- The toilet, bathroom or kitchen facilities are shared amongst tenants.
The local authority can impose licencing additional types of HMO property, e.g a 2 storey property or a flat, to be licenced as an HMO.
Where the local authority has the power to require designated roads to be licenced which could include non-HMO properties occupied by a single family.
Advantages of investing in a HMO:
Higher returns – combined rent of individual rooms would usually generate a higher rental yield than the same property would as a single home
Reduced void periods – unless the property is a student let, it is unlikely all tenants in the property will leave at the same time. This means that there will always be an income if not at full capacity.
Disadvantages of investing in a HMO:
More regulations and administration– Your client will have to manage multiple tenancy contracts and deposits, higher tenant turnovers and will have to ensure compliance with extra regulations. These include fire safety measures, provision of safety certificates for gas and electrical appliances, as well as responsibility for cleanliness and repairs in the communal areas of the house. Under the new HMO legislation, local authorities are able to take action against landlords.
Higher upfront investments– HMOs are likely to be larger properties and therefore have a higher purchase price, higher maintenance costs and extra expenses from letting agents.