How Much Buy-to-let Deposit Do I need?
Deposit and Mortgage
If you are thinking of purchasing a residential property and then renting it out, a popular way of financing the arrangement is with a deposit plus a “buy-to-let” mortgage (normally provided on an interest only basis).
In theory it should be easier to secure such a mortgage because the rules governing the maximum amount that banks and building societies can lend are not as harsh as apply to residential mortgages. In practice however securing a “buy-to-let” mortgage, particularly if you are seeking a competitive rate of lending, is not always a straightforward transaction. You should also not underestimate the size of deposit that you will also need to find.
The Lender’s Valuation
The first important principle to grasp is that it is the lender who determines the value of the property for lending purposes rather than the buyer (you) or the seller or the agent or even the “market”. You may be happy to pay say £300,000 for a lovely flat and be confident that you will let it out for a minimum of £1500 per month but if the lender values the property at say £250,000 it will be his valuation that is the important one not yours. Why? Because the maximum amount that he will be prepared to lend will be based on his valuation unless you can persuade him otherwise.
The lender’s valuation of the amount of prospective rental return is also crucial in calculating the maximum amount that he is prepared to loan.
The following is an example of a typical formula that a lender might use: –
Amount of loan times “nominal” interest rate (5% has been a typical rate used by lenders) divided by 12, then multiplied by 125%
equals the minimum amount of rental income required per month to cover the monthly mortgage payments i.e.
Amount of loan = £100,000;
“Nominal” cost = (£1000,000 x 5%) – £5000
Divided by 12 = £416.67
Times 125% = £520.83
This is the minimum monthly amount of rental income which the lender will accept for loaning an amount of £100,000. The lender will then review the market for similar buy-to-let properties and will estimate the expected amount of rental income that your property might attract – if the estimate is under £520 per month, then the amount of loan will be reduced accordingly or the offer of a mortgage declined entirely.
How much Deposit?
But how much deposit will you need to put down to meet the lender’s requirements?
20% is a typical minimum (i.e. £24,000 on a property valued at £124,000.). An experienced mortgage broker with good contacts may very occasionally be able to negotiate a lower deposit in certain circumstances but you should assume a 20% figure as an absolute minimum.
Dependent on various factors a larger deposit may be required in individual circumstances and remember the higher the deposit then generally the better the interest rate that will apply.
What rate can I expect to pay?
Okay let’s assume that you have met the lender’s criteria and you are able to proceed. No doubt you will have seen in the press or on the internet headlines indicating that mortgage rates have never been cheaper and you may confidently be expecting to stroll into your local building society and secure a deal for the headline rate advertised in the branch window.
Unless you have been very lucky in the selection of your property you could be in for another shock.
Lenders apply very strict criteria when determining the rate at which they are prepared to lend. For example, the best rates might not apply if the property you have chosen is a “new build” or above a shop or is a flat within a tall tower block, or maybe on a main road or adjacent to pubs and restaurants or is a leasehold property with less than seventy-five years of lease remaining.
Similarly, if you are a first time investor and/or over age 50 or have a deposit of “only” 25% or 30% you will find that the best rates are normally denied to you. Come back when you’ve scraped together a 40% or 50% deposit and you might be luckier!
Getting the best deal
What can you do to secure the highest amount of loan at the best rate? Sadly, there is no magic wand but getting expert advice at the outset from a property expert and a mortgage broker is likely to give you a better chance than trying to tackle this complex market on your own.
One of our key recommendations is that you consult the experts before you get too far down the line in searching for a property. With the assistance of our panel of high quality and experienced tax, legal and mortgage advisers we can help you choose the best type of property in the most suitable location and on the best financial terms to maximise your investment return.