Buy-to-Let Mortgages vs. Residential Mortgages: Key Differences

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Mortgages are the backbone of property financing, enabling owner occupiers to purchase homes and buy-to-let (BTL) investors to acquire rental properties. While the end goal - property ownership - might be the same, mortgage requirements vary significantly between BTL and owner occupier (or “residential” or, formally, “capital and interest”) mortgages.

Understanding the Key Differences

1. Purpose and Use:

The purpose of BTL mortgages is to provide debt financing for residential properties specifically meant for the rental market. The terms of a BTL mortgage usually prohibit the occupation of the property by its owner and persons related to them. A property investor who takes out a BTL mortgage typically wants to generate rental income from the property which will, ideally, cover mortgage payments and other costs such as letting agent commission, property management fees, service charges, insurance premia, and repair and maintenance expenses, and still earn a profit. The investor also expects that the value of the property will appreciate over time and lead to a significant capital gain. The overall aim is to achieve the desired return on investment.

The purpose of residential mortgages is to provide debt financing for homes which will be occupied by their owners and their families. In contrast to a BTL mortgage, a residential mortgage does not allow the property to be used for rental purposes. Generally, those taking out a residential mortgage, although hopeful that the value of their property will appreciate over time, view it as their family home for the foreseeable future.

2. Interest-only vs. Repayment Mortgage:

BTL: BTL mortgages are typically interest-only mortgages. With this type of mortgage, only interest is paid each month and the entire principal amount is repaid as a single lumpsum only at the end of the mortgage term.  

It is possible to obtain a repayment mortgage for a BTL property, but this is unusual. Under a repayment mortgage, the monthly mortgage payment includes both principal repayment and interest. Because of monthly principal repayments, interest is charged on a reducing mortgage balance over time and the entire loan amount is paid off by the end of the mortgage term.

Residential: Residential mortgages are usually repayment mortgages. 88% of residential mortgages at the end of 2022 were repayment mortgages and another 3% were part repayment and part interest-only. Although in principle possible, it is no longer easy to obtain interest-only residential mortgages.

3. Deposit and Affordability:

BTL: Typically, a minimum deposit of at least 25% of the value of the property is required to obtain a BTL mortgage, usually interest-only. However, following their affordability assessment, lenders may increase the deposit requirement to 35% - 40% or even higher. Lenders’ affordability assessment includes checking that the rental income from the property comfortably covers interest payments calculated at a “stressed” interest rate (i.e. 2% - 3% above the current rate) plus other costs, such as letting agent commission, property management fees, service charges, insurance premia, and repair and maintenance expenses. BTL landlords are also expected to have a minimum personal income of about £25,000 per annum, a strong credit profile and a robust plan for the repayment of the loan at the end of the mortgage term, such as savings or an investment portfolio not including the mortgaged property itself.

Residential: The minimum deposit requirement for a residential mortgage can be as low as 5%, especially for first-time buyers. For those who do not fall into this category, it is not unusual for deposits to be of the order of 10% or higher. The maximum loan amount is usually of the order of 4 – 4.5 times the borrower’s annual income, although it can sometimes be higher. However, this is subject to affordability assessment, which will usually take into account basic living costs, such as food, utility bills and clothing, and other applicable expenses, such as those related to credit cards, overdrafts, council taxes, loan, hire purchase agreements and school fees. A full personal credit check will also be carried out by lenders.

4. Mortgage Interest Rate:

BTL mortgage interest rates are usually higher than residential mortgage interest rates. For example, the current average 2-year fixed BTL mortgage rate on a 75% loan-to-value mortgage charged by the largest six lenders is 5.31%. The comparable residential mortgage rate is 4.99%.

5. Taxes:

So far as owner occupier residential property is concerned, if after buying the property it is the only property the buyer will own, the stamp duty land tax (SDLT) thresholds and rates that apply are as follows:

Property purchase price SDLT rate
Up to £250,000 Zero
The next £675,000 (from £250,001 to £925,000) 5%
The next £575,000 (from £925,001 to £1.5 million) 10%
The remaining amount (above £1.5 million) 12%

First-time buyers pay lower rates, provided that the price of the property does not exceed £625,000:

Property purchase price SDLT rate
Up to £425,000 Zero
The next £200,000 (from £425,001 to £625,000) 5%

However, the rates on BTL properties and second homes are 3% higher for each band:

Property purchase price SDLT rate
Up to £250,000 3%
The next £675,000 (from £250,001 to £925,000) 8%
The next £575,000 (from £925,001 to £1.5 million) 13%
The remaining amount (above £1.5 million) 15%

With a BTL property, 20% of the mortgage interest cost, as well as other allowable expenses, can be deducted from rental income for calculating taxable profit. Owner occupiers, however, cannot deduct residential mortgage interest for tax purposes.

Conclusion

Whether you are drawn to the potential returns of a rental property or seeking a place to call home, if you want to raise debt finance, it is worth being aware of the key differences between BTL and residential mortgages. In addition to doing your own research and financial planning, you should consider seeking the advice of an independent mortgage broker or financial advisor.

FAQs:

Q. Can I use a residential mortgage for BTL?

A: No, you cannot use a residential mortgage for a BTL property. Residential mortgages are designed for properties where the owner and their family live. If you plan to rent out your property, you must obtain a BTL mortgage. However, if you initially bought a property with a residential mortgage and decide to rent it later, you must obtain your lender’s consent. Your lender may consent to your renting out your property with a residential mortgage if this is for a good reason and on a temporary basis, such as your employment posting you to another city. However, if you are planning to rent out your property on a permanent basis, your lender will almost certainly require you to switch to a BTL mortgage and this may well include a new affordability assessment.

Q. What are the tax implications of owning a BTL property?

A: Owning a BTL property comes with several tax implications:

Stamp Duty Land Tax (SDLT): Purchasing a BTL property requires paying SDLT at a higher rate. Each band has a 3% surcharge on top of the standard SDLT rates for UK residents. Non-residents pay a further 2% surcharge.

Income Tax: The taxable profit on a BTL property is subject to income tax. It is determined by deducting allowable expenses from rental income. Such expenses include 20% of mortgage interest, letting agent commissions, property management fees, service charges, insurance premia, repair and maintenance expenses, and the allowable percentage of wear and tear with respect to furnishings.

Capital Gains Tax (CGT): If you sell your BTL property for more than what you paid for it, you will be liable for CGT on any gains after deducting the allowable expenses, such as stamp duty and selling costs.  

Q. Are there any government schemes available to help with BTL purchases?

A: There are some government schemes for prospective owner occupiers who fall into certain categories. For example, the Forces Help to Buy Scheme provides interest free loans to serving military personnel of up to 50% of their salary, but capped at £25,000, which can be applied to deposits and legal costs connected with the purchase of property for occupation by owners. The First Homes Scheme is aimed at eligible first-time buyers looking to purchase their first home for owner occupation at a 30% - 50% discount to the market price. Investors looking to purchase BTL properties, however, do not qualify for any such schemes. Independent financial advisors or mortgage brokers might be able to help find suitable BTL mortgages.

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