How to start investing in the property.
Investing in property can be very beneficial, especially when the interest rates for savings and bonds are very low and people are searching for alternative ways to invest their money.
If you are considering becoming a property investor or just want to buy a second home to be rented out, here you can find all information about how to start your journey. Over the coming articles, we will cover the funding options, rental cover ratio, SPV limited company set up, taxation, allowances, insurance, and maintenance.
Investing in property basics.
A buy-to-let mortgage is a first-charge, secured loan on a property that is intended to be let out to tenants, rather than lived in by the borrower. The BTL mortgage typically will be interest-only, which means that the capital owned will not be repaid over time and the property will not become debt-free at the end of the term. The investor will have an option to sell the property to pay back the loan or refinance again at the end of the term. Buy-to-let mortgages have a higher age limit and are suitable for retirement investments.
What is Rental-Cover Ratio?
When considering a property investment, every budding landlord needs to assess the viability of the investment. This is when comes your rental-cover-ratio. For the financial institution to lend money for the property, they need to be satisfied that the property will pay for the mortgage, insurance, fees (e.g. letting agency fees) and maintenance and repairs.
To explain this in an example, we will take a property that is worth £300,000 with a 75% LTV mortgage of £225,000. To calculate the affordability of the mortgage, lenders will use the stress test interest rate, which is 5.5% at the moment and the rental cover ratio of 145%.
To start we need to calculate the maximum annual interest value. To do so we will take the mortgage amount multiplied by the interest rate of 5.5%, which will be our stress rate (a maximum interest rate payable, so-called notional rate). The stress rate is higher than the actual interest rate payable to account for future interest rate rises.
£225,000 x 5.5% interest rate = £12,375 Annual Interest
Annual interest is the maximum interest you will pay on your mortgage. Now we need to make sure that the rental income will cover the maximum interest and will leave enough to cover the rest of the costs and generate income.
£12,375 annual interest x 145% rental cover = £17,944 Minimal Annual Rental Income /12 months = £1,495 min monthly rental income.
This means that the interest is only 69% of the overall income from the rental property.
If the property will not achieve the recommended rental income, some lenders will look into personal income to cover the shortfall of the 145% rental cover. For example, if the above property can only be rented out for £1,300 the investor needs to have an additional disposable income to cover the difference. This is called top-slicing.
Documents needed to apply
To apply for the buy-to-let mortgage you will have to gather several documents, which include, but are not limited to:
- Proof of identity – We need proof of ID to help protect against fraud. The Anti Money Laundering regulations (AML) require us to check the names and addresses of all our clients. This can be done through video conference (Zoom meeting) or mobile video calls (Whatsapp, Messenger)
- Proof of address
- Proof of income
- Employed – 3 months payslips
- Contractors – a current contract
- Self-employed or limited company director – two years of SA302 tax returns, two years tax statements,
- Bank statements – 3 months of bank statements
- Proof of deposit
- Property details – rental income, value
- We can also request a recent credit report, which can be obtain from CheckMyFile
Many lenders will not consider applicants with adverse credit history. Those who have ever been declared bankrupt, been subject to IVA, had CCJ or had their property repossessed.
Before you apply for any mortgage, check your credit history and your credit score. You must understand your credit score as lenders will look at your credit history and will base their decision on the results.
Before you start investing in property, investigate the property rental market in the area, postcode search and how popular the area is with renters. Some postcodes are not achieving the best rental income because they are more popular with older people or with commuters, who prefer to buy than rent. Check out Zoopla historic house prices to find out how much the properties are worth in your chosen area.
When planning the purchase of your first investment property it would be beneficial to speak to a specialist accountant. Please make sure your chosen accountant is proficient in property law.