Buy to Let Mortgages

Buy to let mortgages became an increasingly popular investment over the last decade. A buy to let mortgage allows you to create an earnings stream from rental income. At the same time buy to let mortgages offer exposure to the housing market allowing you to benefit from any capital gain in the value of your rental property. But the credit crunch and falling house values have exposed many buy to let investors to potential losses.

Association of Residential Letting Agents ARLA is the only professional self-regulating body to be solely concerned with residential lettings and you should find a local member of ARLA who can tell you what the market conditions are like. In some areas demand will be high for family homes elsewhere a one-bedroom flat may be more easily let.

RICS guide Letting Your Property takes you through the basic steps to make sure you are ready to look for a tenant and explains the legal background.

Help Sheet IR283 Private Residence Relief . It may be possible to fragment the ownership amongst your family to maximise the CGT annual exemption. For example an individual will only have an annual exemption of £9600 to set against any gain. However if for example the property is owned by husband wife and two children then there would be four times the annual exemption available thereby giving a total exemption of £38400.

Who wants to be a landlord?

Lets face it landlords have had a bad press over the years - sometimes with justification think Rachman think Hoogstraten and sometimes for comic effect think Rigsby the sleazy character in the 1970's TV sitcom Rising Damp. So why would you want to be a landlord? For many the simple reason is because buying property which you then rent out can provide you with a regular income, not to mention during a period of rising house prices the potential for capital growth in the medium to long term. Many people in recent years have seen investing in a buy to let property as a pension - the monthly rent may be a useful supplement to other retirement income or the property could be sold and the proceeds used as a nest-egg. However buying to let is certainly not a get-rich-quick scheme. Remember that you are investing in an asset that has "low liquidity". This means you won't be able to get your capital back out in a hurry if you need it fast. You may also find in an environment of falling house prices that the value of your property falls below what you paid for it. Investing in rental property may make sense as a part of a broader investment portfolio and you may wish to take independent financial advice about how a buy to let property would sit in your investment portfolio.

What kind of property should I be investing in?

Don't buy a house or flat just because it would appeal to you. You must put personal taste aside and look at property from a purely commercial viewpoint. It would be prudent for example to ask a letting agents advice on what type of property is suitable for rent in the area you are looking to buy in. Many buy to let landlords are discovering in the wake of the credit crunch that they own properties that have fallen substantially in value and that are difficult to let - being the wrong kind of property in the wrong location. The main factors to consider are location type of property and how best to equip and furnish it. Letting agents say good selling points include stripped wooden floors rather than carpets generous storage and fitted wardrobes while appliances you may wish to install could include a dishwasher, microwave oven, washer-dryer and power shower. Good research is as vital for the property you want to let as it is for the property you live in! Is it close to transport links? What sort of parking is there? How far away and how good are the local amenities such as shops and leisure facilities?

Will I be able to get a mortgage?

In the last decade several lenders began to compete to offer a new breed of buy to let mortgage sometimes known as a residential investment loan. Loans available included capital and interest only endowment pension or ISA-linked or a mix of them all. Some allowed for overpayment and payment holidays potentially useful for void periods when the property is empty. The credit crunch and an environment of falling house prices has hit the buy to let mortgage market hard with many mortgage products being withdrawn. Traditionally mortgage lenders used to consider property investors as high risk and tried to put them off with high interest rates and surcharges - the market appears to be returning to this kind of outlook. Those buy to let mortgages still available take rents achievable into account that is to say your lender will calculate the amount they are willing to lend against the potential income you may get from renting the property out. Some lenders will go further expecting investor landlords to consider building-up a mini property investment portfolio and be prepared to take on substantial levels of debt to do so. Loans of £25000 to £1 million are available for periods from five to forty-five years and for up to 85% of valuation. As a rule of thumb potential lenders will expect the rent to be charged to be between 130%-150% of the mortgage costs. They may also stipulate who you may or may not take as a tenant. You may find diplomatic and DSS tenants are excluded. Some diplomats in the past have used diplomatic immunity to avoid paying rents while DSS tenants may be excluded because some local authorities are late with rent payments and refuse to re-house tenants without a repossession order. Exclusions on property type can include freehold flats or maisonettes and not more than one kitchen or five bedrooms in case the property is used for bedsits. Generally it is a condition of buy to let mortgages that tenancy agreements are drawn up as Assured Shorthold Tenancies except where the rental value exceeds £25000 a year and falls outside the provisions of the Housing Act. Then a tenancy drawn up under contract law would apply.

Should I manage it myself or use an agent?

The way you let your property out may be stipulated by your mortgage lender. You should make sure you are aware of the different kinds of occupancy and tenancy agreements that are open to you to arrange and the legal rights and obligations that are conferred by any agreement you enter into. Using a letting agent will obviously impact on your rental income because of the commission charged. However a good agent will take a lot of the work and worry of running a rental property off your back even arranging for repairs and refurbishment when necessary. Landlords who use agents simply to find tenants can expect to pay at least 10% of rental income in fees. The Association of Residential Letting Agents can provide you with a list of its members - membership means that the agent has professional indemnity insurance should something go wrong.

What kind of return can I expect?

According to rentright www.rentright.co.uk , the average monthly rent in Great Britain in June 2008 was £602 the average rent for a one-bed flat in London was £710 and for a four-bed house £1217. Source rentright 26/06/08. However those numbers do not take account of costs. The term used by letting agents and landlords to measure the investment performance of a property is yield and it is usually expressed as a percentage. If say you buy a flat for £100000 and the yearly rental income is £5000 then the yield is 5. For Q2 2008 the Association of Residential Letting Agents ARLA reports the average weighted rental return on a rented house at 4.8% down from 5.0% in Q1 2008. Over the same period the average rental return on a rented flat also fell from 5.0% to 4.8%. The average void period length of time the property stands empty fell from 24 to 22 days per year. Source ARLA Members Survey of the Private Rented Sector Q2 2008. Common to all areas and locations is a simple truth. It is not the most expensive properties that produce the best returns or let the fastest. You also need to take account of the void period - on average rental properties now stand empty almost one month in 12 between lets. Two or three months without a tenant paying rent could make a significant dent in your overall return because you would still have to find the mortgage payment and fund any other expenses. Anybody who purchased a buy to let property more than a year or two ago may already be sitting on a capital asset that has appreciated. Whether these potential gains are maintained over the next few years is more problematic indeed some purpose-built buy to let properties have fallen sharply in value - Source BBC News 16/06/2008. Despite these caveats demand remains strong for rental property of the right type in the right place at the right price.

Will I need a landlords licence?

The answer is maybe! It depends on the type of property that you are renting out and to whom you are renting it. Since 6 April 2006 landlords of properties that house five or more separate tenants and that are at least three storeys high must apply for a mandatory licence from their local authority and satisfy a clutch of rules. The criteria range from upgrading fire and safety regulations to installing a wash basin in every bedroom. Landlords of such houses of multiple occupancy HMO's have a three-month period in which to seek a licence. The cost of the licence has not been set by the government and varies from local authority to local authority. Failure to apply for a licence could result in a fine or legal action against you. It was estimated that around 10% of the 2.6m private rented UK households may be defined as HMO's Source Financial Times 01/04/2006. The licensing rules also stipulate that HMO's not subject to mandatory licensing may still be liable for additional or selective licensing. You will need to check with your local authority. To qualify for a licence HMO's will be visited by a council inspector to check they comply with the required standards. The purpose of the rules is to improve the quality of accommodation available for groups of students and young professionals. However it may also raise the cost of their accommodation since many landlords will seek to pass on their own increased costs to their tenants.

What's the tax status of rental income?

Any rental income you earn is subject to income tax at your highest or marginal rate of income tax but the Inland Revenue makes generous allowances. For a start the interest on your buy to let mortgage will be eligible for tax relief. You may also deduct the cost of a variety of expenses such as agents fees and property repairs and refurbishment against the rent you receive. In addition where the property is let furnished you are allowed a deduction for wear and tear on furnishings and household equipment broadly calculated at 10% of the rent. Your tax liability will be based on your net income from the property after you have deducted the following costs.

• interest payments on your buy-to-let mortgage but not capital repayments
• mortgage arrangement costs
• maintenance costs such as painting and decorating
• 10% a year depreciation of furniture value
• cleaning
• ground rent service charges and buildings insurance where applicable
• advertising the property
• letting agents fees
• accountants fees
• insurance policies on white goods gas boilers plumbing
• any incidental costs of disposal such as estate agents and lawyers fees
• the original acquisition cost

Will I pay tax when I sell the property?

You will have to pay capital gains tax CGT on the difference between the buying and selling prices less certain allowances and tax reliefs. CGT applies when selling a property that is not your primary residence. CGT is now charged at a straight 18%. The calculation of the gain involves deducting from the sale proceeds.

You may include certain costs in the purchase price - such as permanent improvements you have made to the property like the installation of central heating, double glazing or an extension. But you can't claim for basic items such as furniture fixtures and fittings or repair and maintenance bills. When it comes to calculating the actual net gain or profit on your selling price you may deduct legal fees, 'estate agents commission and advertising costs but you can't claim the cost of any early repayment charges if you are redeeming a mortgage early. Each of us is allowed to make a certain amount of capital gains each year before tax. The exemption allowance for 2008/09 is £9600. Assuming you have made no other capital gains this amount can be deducted from the net gain to give the chargeable gain on which capital gains tax is charged at 18%.

How can I limit my tax bill on disposal?

If you move into your buy to let property after the last tenant has moved out you may claim the property as your principal residence and in doing so the last three years worth of gains become tax free. However to claim this relief you must actually take up residence and be able to prove that you live there - for instance by having your mail redirected and being able to show that you used the facilities there by keeping copies of utility bills. An unmarried couple owning say two buy-to-let properties may claim one property each as their principal residence providing they can prove that they really did live in each property for a certain period of time. Furthermore if the property was ever formerly your main residence i.e. your home you are exempt from CGT, if you sell within three years of it becoming a rental property. Where a gain is made on disposal of a property that has been your main residence at some point but has also specifically been let as residential accommodation then a further special relief is available. This exempts a gain of up to £40000. More information is available from the HM Revenue & Customs. This information is based on current understanding of current law and HM Revenue & Customs practice both of which may change in the future and such changes cannot be foreseen. You should seek independent financial advice before undertaking investment activity.

2009-03-09 16:58:40 © Moneyextra.com

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