Types of Buy To Let Mortgage
1. Repayment or Interest Only Buy to Let Mortgage
When taking out a buy to let mortgage, the first thing to consider is if you wish to take a repayment mortgage or an interest only mortgage. As the name on the tin suggests, with a repayment mortgage your repayments will include a certain amount that goes towards paying down the mortgage so that at the end of the mortgage term, usually 25 years, the mortgage will be paid off whereas with an interest only mortgage you will not pay anything towards the actual loan so at the end of the mortgage term you will still owe the full amount you initially borrowed.
The main advantage of a repayment mortgage is that you are paying off the loan and will one day own the property outright meaning any rental income will be all yours but as a result of paying towards the loan your monthly mortgage payments will be higher than if it were only the interest you were paying and so for the next 25 years you will get less of the rent you receive.
On the other hand, taking an interest only mortgage will have significantly lower monthly payments than a repayment mortgage but you will have to an ‘exit plan’ to satisfy the lender you will be able to clear off the debt should you ever reach the end of the mortgage term. This can simply be the intention to sell the property to realise the asset paying off the loan with the proceeds. But in reality most mortgages don’t ever reach their ends in this way as most landlords would remortgage onto a new 25 year deal or sell long before the 25 years is up.
2. Regulated or Unregulated Buy to Let Mortgage
Most buy to let mortgages are known as ‘unregulated’ or ‘investment property’ loans and are designed for landlords who intend to buy a property with the intention of then letting it out to renters. But in some circumstances a ‘regulated’ or ‘accidental landlord’ mortgage will be required, for instance a buy to let mortgage to refinance an inherited property might fall into this category or if the property will be rented out to family members.
3. Fixed Rate BTL Mortgage
A fixed rate loan, as the name suggest, has a fixed interest rate for a certain length of time at the start of the mortgage. They are typically fixed for 2 or 3 years but it is possible to have a fixed rate for 5 or even 10 years should you wish. There will probably also be a ‘tie-in’ for the same length of time meaning you will pay an ‘early redemption charge’ (ERC) should you decide to repay the loan during this time.
Lenders use the Bank of England’s (BOE) base rate as a guide to set many of their interest rates so should you believe the base rate will rise over the coming years then taking out a fixed rate mortgage could be a good idea as you are guaranteed it will not rise during the fixed rate period.
4. Tracker BTL Mortgage
A ‘tracker’ mortgage will track the Bank of England’s (BOE) base rate at a certain percentage above or sometimes even below (a discount tracker) for the initial promotional period of 2 to 5 years. For instance you may have an initial rate of 1.39% above the Bank’s base rate (BBR) which is currently 0.75% so you will pay a rate of 2.14% until the the BBR changes at which point your rate will track the BBR up or down.
A tracker mortgage will be suitable should you believe the BBR is likely to reduce in the future although in this day of ultra low interest rates there isn’t really much lower that it can go so many people opt for a fixed rate deal.
5. Standard Variable Rate BTL Mortgage
A lender’s standard variable rate (SVR) mortgage is what your fixed rate or tracker deal will switch to should you not remortgage before the end of the initial ‘tie-in’ period. It tracks the Bank of England’s base rate (BBR) but will be considerably higher than the promotional rate you have been paying so it is essential to switch before your deal ends.
For instance you may have a fixed rate deal for 3 years at 3.39% which will revert to the SVR of 5.23% at the end of the 3 year period, a jump of almost 2% which, on a £150,000 mortgage, would mean your monthly interest payment would rise by around £230!
So it is essential to start thinking about remortgaging your buy to let property at least 3 or 4 months before the end of your tie in to ensure you have enough time to switch before the end of your deal.
6. Capped Rate Mortgage
A capped rate buy to let mortgage is a variable rate mortgage (i.e. it moves up and down with the Bank of England Base Rate or BBR) but with a ceiling or cap to prevent the rate rising above a certain level. It will typically have a higher initial rate than a tracker mortgage to account for the extra risk the lender is taking that rates will rise above the cap’s level.
If you are uncertain which way interest rates are going to go then perhaps this might be the best option as it has the flexibility to follow rates down but you won’t have to worry too much if they start to rise precipitously.
7. Libor Buy to Let Mortgage
Short for London Interbank Offer Rate, the Libor mortgage is similar to a tracker or variable mortgage but tracks the Libor rate rather than the Bank of England base rate. The Libor rate is set on a daily basis and is the rate that banks charge each other to lend money on a short term basis. Your Libor mortgage rate will be based on the Libor rate plus the margin added by the lender, say 1.49% and will be updated to reflect the current Libor rate every 3, 6 or 12 months depending on the terms of the mortgage.
As with the other types of mortgage there will usually be an initial tie in period that will mean you will have to pay an early redemption charge (ERC) should you pay off the loan early. When interest rates are low a Libor mortgage could work out cheaper than other mortgages but in this volatile world who knows what will happen to the Libor rate in the future as, unlike the Bank of England Base Rate, it is prone to wild fluctuations so you must be prepared for a rise in your repayments should this happen, although it is also possible to get a cap to prevent the rate rising above a certain level.
8. Stepped Rate Mortgage
A stepped rate BTL mortgage will start off at a certain level then rise up in steps at predetermined times during the initial promotional period. The advantage of a stepped mortgage is it will invariably start at a level below a fixed or tracker mortgage but it will then rise and could become significantly more expensive.
If you are buying a property that needs refurbishment then a stepped rate mortgage might be suitable as the initial payments will be less so it will be easier to afford before you start receiving rent from your tenants.
9. Other Buy to Let Mortgage Features
Although the headline rate is the main aspect of a mortgage it is worth understanding the other features you may encounter as they can all affect how much you will end up paying:
Loan to Value
The LTV is the percentage of a property’s value that a lender will loan to you. Typically the higher the LTV the higher the risk for the bank and hence the interest rate will be higher. So you may be able to get a 2 year fixed rate deal at 2.09% if the loan to value is 60% or less (you will be borrowing 60% or less of the value of the property) but a 2 year fixed rate mortgage from the same lender may attract a rate of 2.36% if you are borrowing 75% of the value of the property.
Most mortgages will involve an arrangement fee which the lender charges for arranging your mortgage. This can be a few hundred pounds or even a few thousand depending on the mortgage and is sometimes set at a percentage, say 1%, of the total loan amount. It is possible to find buy to let mortgages with no arrangement fee but they will usually have a higher interest rate.
Early Redemption Charge
Any mortgage that offers an introductory rate during an initial tie in period will usually have an Early Redemption Fee (ERC) that will be payable if you redeem or pay off the mortgage during this time. It will be detailed in the terms of the mortgage and usually is on a sliding scale, the longer you have the mortgage the less you will be liable to pay. i.e. in the first year of a 3 year fixed rate mortgage you may have to pay an ERC of 3%, in year two 2% and year three just 1%.
Watch out for an ERC overhang though, as this means the mortgage will have an ERC even after the initial pay rate has ended and you will then have to pay the bank’s standard variable rate or SVR.
The other fees that you may come across are valuation fees and solicitors’ fees if its a remortgage. Again these vary hugely between products but are usually a few hundred pounds each unless you find a mortgage with these fees included in the deal.
Another way lenders entice people to take their mortgage is by offering cash back, which does what it says on the tin. Upon completion of the mortgage you will be given the set amount of cash to do with as you see fit.
10. Choosing a Mortgage
When choosing which buy to let mortgage to take don’t just focus on the interest rate as this can sometimes be very misleading. If a mortgage has the lowest pay rate, the lender will often look to recoup the difference in other fees and conditions of the mortgage.
For instance a 3 year fixed rate deal at 2.09% may sound much worse than a mortgage from another bank that is fixed at 1.49% for the same period but if the first has no arrangement or valuation fees and offers you £500 cash back upon completion you will actually pay £5,770 over the course of the 3 years. Whilst the other mortgage may incur an arrangement fee of £999 plus a valuation fee of £500 meaning you will pay £5,970 over the same introductory period.
So it is essential to weigh up the pros and cons of each deal and compare them against each other as best you can to see which one will be right for you.