Owning property to rent out can be a great investment for many reasons. As with all property, it is likely to be one of the largest assets you own and often tends to increase in value over long periods of time. By renting out a property, you can also earn a monthly income, which can be a great revenue stream for people of all ages, particularly for those nearing retirement age that might be looking to bolster their pension or replace income earned. Cash buyers will be able to purchase a second property outright, and those who have some cash to put towards the purchase of a second or third property will need to consider a Buy to Let mortgage. Below, we'll look at the key factors you'll need to consider before becoming a Landlord.
Stamp Duty – Additional 3% for Buy to Let
If your rental property is to be at least the second property you own, you will have Stamp Duty liabilities to consider. In England and Northern Ireland, any ‘additional’ properties costing over £40,000 will incur a Stamp Duty taxation cost, for freehold or leasehold properties and applies regardless if the property is bought with cash outright or mortgaged. Buy to Let or additional residential properties incur a 3% charge on top of the usual Stamp Duty rates. The table below from moneyadviceservices.org shows the taxation rate for residential properties – for Buy to Let’s, you will add 3% to each bracket:
So, if your Buy to Let property was purchased at £250,000 you would pay:
3% on £40,000-£125,000 = £85,000 x 3% = £2,550
5% on £125,001-£250,000 = £125,000 x 5% = £6,250
TOTAL Stamp Duty due = £8,800
If you are a cash buyer, you can ignore this section as you will not need to mortgage the property, but instead will own it outright.
You will usually need a minimum deposit of 25% of the property value, but some Buy to Let mortgages may be available with a deposit of 20% or less, from selected lenders. If you would like to invest with a smaller deposit, speak to a mortgage advisor who will be able to guide you on this.
Buy to Let mortgage lenders will usually want to see that the rental income will cover the mortgage payments, usually by around 145%, but will vary from one lender to the next. As with a residential mortgage, lenders will take into consideration your earned income and committed expenditure (loans, credit cards, HP agreements) to ensure that the loan is affordable to you now and in the future. Additionally, any existing mortgage agreements you have in place will be considered. It’s worth checking your credit rating and speaking to an independent mortgage advisor who will be able to source the best lending options for you, based on your specific situation and requirements.
At this stage, it is also worth considering the rental income of the property. This is important, especially if the property is to be mortgaged, as you will need to ensure that the monthly rental income is adequate to cover at least the monthly mortgage payment and any running costs of the property. If you aren’t sure how much the property could achieve in the rental market, speaking to local Lettings Agents or researching average rental costs for a similar property within the same area will give you realistic expectations and figures.
What is meant by Rental Yield? In simple terms, Rental Yield is a percentage, calculated by dividing the annual rental income achieved, by the market value of the Buy to Let property. For instance, if the property is valued at £200,000 and the market rental value is £950 per month, you would multiple 950 by 12 (assuming the property is occupied by a tenant for 12 months of the year) = £11,400, then divide 11,400 by 200,000 = 0.057, so around 5.7%.
Knowing the Rental Yield can be very useful as an investor, as it allows you to compare properties based on their value as a rental investment. Of course, other factors will be a part of this consideration such as rental climate within an area and the likeliness of overall capital growth on the property, over time. Other costs to consider when comparing properties would include any upfront renovation costs to make the property habitable and achieve the best possible rental income, as well as nearby schools and transportation access, which potential tenants may deem important and therefore find one property more desirable over another.
As a guide, a 'good' Rental Yield is considered by investors to be between 6-8%.
You may or may not be aware that as of last month, April 2020, tax relief costs for landlords have changed. They are now restricted to the basic rate of income tax which is currently 20%.
In previous years, landlords were able to offset mortgage interest and other allowable costs from the rental income when calculating the final rental income taxable amount. Relief from April 2020 will now be given as a reduction in tax liability, instead of an overall reduction to the taxable income. Your tax liability from rental income will be assessed based on your tax band for earned income, for instance, a Basic Rate taxpayer will pay tax at 20% on earned income between £12,501-£50,000, Higher Rate taxpayer will pay tax at 40% on income earned from £50,000-£150,000, and Higher Rate of 45% on earned income over £150,000, so depending on which category you fall in to will determine the level of taxation on rental income.
Click here for a table provided by The Mortgage Works, which illustrates the difference in cost between the old and current system. All figures are for illustrative purposes only.
The next cost to consider is Landlord’s insurance. Whilst Landlord insurance is not a legal requirement, some lenders make it a requirement for a Buy to Let mortgage. It is advisable that you have a policy (or multiple) in place to ensure that there is adequate cover against the various potentially costly outcomes of having a tenant living in your property. The insurance is there to protect you, the landlord from incurring costs relating to accidental damage to the property, loss of rent if the tenant is unable to or refuses to pay, and personal liability insurance in the event that the tenant injures themselves or becomes unwell due to negligence in the upkeep of the property.
When considering the steps to become a landlord, insurances can often be overlooked. If you are to be renting out the property furnished, you may want to consider contents insurance as a policy inclusion. The team at The Mortgage Library can assist you in sourcing the right cover for yourself and your property. It is also worth looking at various options online to gain an understanding of the various options and what exactly they cover.
Some areas in the UK require Landlords to have a specific license. Depending on the area of your purchase, this may be something you need to apply for from the local council. If you are thinking of letting out the property to 5 or more people who aren’t from the same family (such as students), you must apply for an 'HMO' license (House in Multiple Occupation) which is mandatory in the UK. Applying for a license will involve ensuring the property is suitable for the occupants, by providing certification for gas safety, smoke alarm maintenance and certificates for all electrical appliances (if applicable). Other licensing is known as 'Selective' and is restricted to designated areas or streets.
You can apply yourself for the relevant license by looking at the local council’s website, or if you will be using a Lettings or managing agent they may apply on your behalf.
Lastly, when considering how to become a landlord in the UK, it’s important to remember that your property may not always be let to tenants. There may be times when occupants move on and the property is left empty for a period, or other unexpected costs may arise – such as having to repair or replace a boiler. I recommend always having available funds in a savings account for if or when these instances may arise so that you’re able to make mortgage payments regardless and can cover any additional costs without having to borrow or raise funds elsewhere.
If you have questions about the process, or would like some clarification on any of the points covered, give The Mortgage Library a call on 01702 899072 and one of us mortgage boffins will gladly provide more details and confirm the best way forward for you.