What you need to know

Many buy-to-let lenders now charge less than 5% on their fixed rate deals. This is a fall from the near 7% rates seen in July.

A buy-to-let mortgage is a loan specifically for those who are buying property as an investment. It is different to a residential mortgage which is used to buy a home for you to live in.

Here we explain the ins and outs, from mortgage rates to tax rules and calculating how much you can afford.

In this article, we cover:

Read more: Is becoming a landlord still worth it?

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Is buy-to-let investment worth it?

The lustre of buy-to-let has faded significantly in recent years. A variety of government measures and rising interest rates has made property a less attractive investment than it used to be.

In addition, buy-to-let investors are having to manage their portfolio in a heightened interest rate environment. Since December 2021 the Bank of England has raised its base rate 14 times, from 0.1% to its current figure of 5.25%.

Mortgage-holders have been hit badly, especially those with a buy-to-let loan. And rising costs for landlords are likely to be passed on to tenants.

You also need to take into account the interest coverage ratio (ICR) which is how buy-to-let mortgages are assessed. This ratio compares the rental income to mortgage interest payments.

While the criteria may vary between lenders, a lower-rate taxpayer would typically need the rental income to exceed the mortgage payment by 125% to qualify. Meanwhile, a higher-rate taxpayer would face a more stringent requirement, usually of around 145%.

Investing in buy-to-let can therefore carry significant risks and is only considered suitable for people who have a financial cushion to soak up unforeseen costs.

Managing a property can also take up a lot of time and should not be seen as a short-term investment.

On the other hand, while the environment looks difficult for landlords and property investors, the fundamentals underpinning the buy-to-let market for investors remain robust.

Average rents for new-lets rose 10.5% in the 12 months to September, according to Zoopla’s latest Rental Market Report.

While the real estate company expects rental growth to slow to between 4% and 5% by the end of 2023, it also believes the ongoing problems with supply and demand will continue.

Experts are confident that there is still money to be made, especially in areas popular with workers and students, pushing up demand and therefore rent (see below: where to buy)

Read more: What do UK interest rate rises mean for you?

What is a consumer buy-to-let mortgage?

These mortgages are designed for non-professional landlords or ‘accidental’ landlords, i.e. those people who find themselves with a property to rent out due to unforeseen circumstances.

Consumer buy-to-let mortgages are regulated by Financial Conduct Authority (FCA) like a residential mortgage.

Most buy-to-let mortgages are not regulated by the FCA, however, as they are seen as a commercial and not a consumer transaction by professional landlords who operate their property portfolios as a business.

Read more: Guide to buying a second home

Am I eligible for a buy-to-let mortgage?

The eligibility criteria varies between lenders, although most require you to be at least 21 years old before you can apply for a buy-to-let mortgage.

You are also likely to need a good credit score so it worth checking yours before you apply and improving it if you need to.

While a standard residential mortgage can be secured with as little as 5% deposit, the minimum required for a buy-to-let mortgage is usually 25%. The amount varies between lenders, some may require a deposit as high as 40%.

Typically, you also need to earn at least £25,000 a year, especially if you are a first-time landlord. 

Read more: The best landlord insurance policies

Will the property be profitable?

You also need to demonstrate that renting out the property will be profitable in order to secure a buy-to-let mortgage.

How to calculate rental yields:

1. Take the yearly rental income of a property
2. Divide this by the amount you paid for the property
3. Multiply the figure by 100 to get the percentage

To get your head round all this, you can use an online rental yield calculator.

Don’t forget maintenance and insurance costs, any managing agent fees, mortgage interest, plus periods in which the property might sit empty. All these costs will eat into the rental yield.

You will also need to show you will still be able to pay the mortgage if interest rates rise.

If you’re a basic-rate taxpayer, the rent has to be 125% of the interest, calculated at a rate of around 5.5%. This rises to 145% for those in the higher tax brackets.

Read more: Tax returns explained – including who has to file one

Are buy-to-let mortgage rates higher?

Some of the fees and the interest rates for buy-to-let mortgages can be higher than for a standard residential mortgage.

Such mortgages are often offered as interest only. This means your monthly payments will be lower than for a repayment mortgage but you aren’t actually reducing the debt.

On the plus side, these mortgages often give you the flexibility to pay off part of your loan each year when your rentals are more profitable. Check first for penalty fees, especially if you have a fixed rate. 

You could sell the property to repay the mortgage. But if house prices fall and the proceeds don’t cover the outstanding debt, you could be in negative equity and may have to make up the difference yourself.

So it’s worth building up a financial cushion to make sure your property empire doesn’t come tumbling down.

What are the buy-to-let tax changes?

In April 2016, the government imposed a 3% stamp duty surcharge on second homes and buy to let properties in England, Wales and Northern Ireland.

Landlords still have to pay the 3% surcharge on the whole property. So if you buy a rental flat worth £400,000, the 3% stamp duty surcharge works out as an extra £12,000.

The surcharge is on top of the usual stamp duty rates.

In Scotland, second home owners and buy-to-let landlords have to pay an extra 4% in stamp duty.

Buy-to-let investors have also been hit with more tax changes.

Until April 2020, private landlords could deduct mortgage interest payments from their rental income when calculating their tax liability – known as mortgage interest tax relief.

However, since buy-to-let landlords now have to pay income tax on the ENTIRE rental income, regardless of how much is swallowed by mortgage interest. 

Landlords can take advantage of a new 20% tax credit on the interest. This makes the change neutral for most of those in the basic tax bracket. Some will lose out though by being pushed into the higher tax bracket because of the new way tax is calculated.

However, landlords who pay income tax at 40% or 45% will be paying far more than before the shake-up. 

Read more: What is income tax and how much do you pay?

Calculating buy-to-let tax

Let us assume monthly rental income of £1,000 and mortgage interest payments of £400. We’re ignoring other expenses that can be set against tax.

• Annual rental income = £12,000 
• Annual interest paid = £4,800

Tax on annual rental income:

• If you pay tax at 20% = £2,400
• If you pay tax at 40% = £4,800
• Tax credit on interest (20% of £4,800) = £960

The tax bill you’ll have to pay:

• Basic-rate taxpayer: £2,400 – £960 = £1,440
• Higher-rate taxpayer: £4,800 – £960 = £3,840

Under the previous tax rules before April 2020, both owners could deduct their interest payments from the rental income before calculating their tax: £12,000-£4,800 = £7,200. 

Do you pay capital gains tax on buy-to-let properties?

A buy-to-let is also subject to capital gains tax (CGT) if you sell the property. From 6 April 2023 everyone is entitled to a CGT annual exemption of £6,000 (down from £12,300 in 2022/23).

The figure will further reduce to £3,000 from 6 April 2024. 

Above the allowance, CGT is charged at a rate of:

• 28% for higher-rate taxpayers
• 18% for basic-rate taxpayers

Any gain will be added to your income if you’re a basic rate taxpayer, so this could push you into to higher-rate band. 

The lower-rate taxpayer had to stump up the same as under the new system — £1,440.

But the higher-rate payer paid nearly £1,000 less — £2,880 — so they are the ones who have really been hit by this new system.

Remember that these figures need to be declared on a tax return.

Read more: 8 things to know about your self-assessment tax return

How can I cut buy-to-let costs?

If you don’t fancy paying so much extra tax on your rental income, you could think about purchasing a buy-to-let property through a limited company.

The sums don’t add up for everyone so you would need to take expert advice before making such a leap. 

If the property is owned by a company, all costs, including mortgage interest payments, can be deducted as business expenses.

The company pays corporation tax on profits, which starts at 19% if your profits are under £50,000.

As a landlord, you can draw income in the form of dividends. In the 2023/24 tax year, the first £1,000 of dividends are tax-free. But you pay tax on further withdrawals at:

• 8.75% as a basic-rate taxpayer
• 33.75% if you fall into the higher-rate bracket
• 39.35% for additional-rate taxpayers

Capital gains tax is also a consideration as the company will be liable for corporation tax on gains if a property is sold at a profit. Then you’ll pay income tax if you need to withdraw the money. 

One advantage of a company is that you only have to take out the money at a time that suits you. This could be in a tax year when other income is low because, say, you take a sabbatical.

Read more: Should I register as an LLC to buy a house?

Do first-time buyers qualify?

In theory, it is possible for first-time buyers to get a buy-to-let mortgage. But in reality it can be difficult as lenders often consider this group too risky. 

The number of mortgages on offer to you will be more limited so you will likely need a bigger deposit to get a good deal.

The lender will look carefully at your circumstances and reasons why you want to purchase a buy-to-let property without having owned your own home.

Using a mortgage broker might help you find a lender that welcomes first-time buyers.  We round up the best mortgage brokers.

Shopping for a mortgage? Try our mortgage comparison tool.

Should I cash in my pension to purchase a buy-to-let property?

If you are thinking about cashing in your pension pot to acquire a buy-to-let property, be careful.

Only the first 25% of your pension will be tax-free if you withdraw it, the rest will be subject to income tax. 

You will have to pay:

If you leave the house to your loved ones when you die, the property will be subject to inheritance tax. Your pension isn’t normally liable for inheritance tax. 

Read more: What is the inheritance tax threshold?

Where should I buy?

If you are looking to buy in an area which will give you the best return on your property investment, here are the places which produced the highest rental yield in the UK according to online estate agent Zoopla.

It might be tempting to snap up a bargain two-bed flat in the north-east when you live in the more expensive south, for example. But be careful: not being familiar with the area can lead to serious losses.

The demand for rentals in the area could be weak or falling, and the ban on most letting fees for tenants may mean estate agents have fled the scene, so you could find it difficult to let the property.

Should you decide to sell the property, you may find yourself taking a hit. So do your research and then do some more.

Also consider the type of prospective tenants in the area: is there likely to be demand from young professionals, young families or students?

That will also dictate the type of buy to let property you purchase.

Should you invest in property? Read our handy Q&A

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