Imagine you had loads of money. A lot! And you wanted to buy a house. You don’t need a mortgage do you? No! You have loads of cash and can buy it outright.
But is that the best thing to do?
A wealthy client of mine decided to buy another property in Edinburgh. It’s a big one and while he could buy it cash, he asked me to arrange a mortgage for him. Why I hear you ask?
There are several reasons why a wealthy client would use a mortgage to leverage a property purchase.
Liquidity – Make your money work for you – if all your cash is tied up in property then it isn’t available for other purposes.
For example, you can borrow against funds under investment. This type of finance is called Lombard and is unregulated and can be used for almost any purpose. It is a popular way to borrow for business purposes. And the rates are very low.
ROI – Return On Investment – money in property appreciates at the same rate as that property. Money invested elsewhere could grow faster.
Cost of debt verses ROI – you can typically borrow for about 3% currently, often less. If you invested funds instead of paying for a property in cash then you could get a better return. A client of mine recently was getting 8% yield on his investment portfolio. He wanted to borrow and keep the funds invested. He then made 5% more on the funds.
Leverage – instead of buying one property in cash, leveraging with a mortgage means you can buy many properties. The more you buy the more capital growth and more rental yield you can enjoy. This is the strategy of most landlords.
Risk – a mortgage is low risk, as long as you maintain payments. Also, linking to the last point, if you have multiple properties then it reduces your risk. Eg if you own four rental properties and one is empty then that’s only 1/4 of your portfolio, only 1/4 of your income is affected, and the other 3 help to support this.
Tax – if you have funds invested and you realease them to buy a property then you could face capital gains tax. If you have a debt against a property then this reduces your inheritance tax burden.
The flip side to this is your attitude to risk. Some people prefer to own everything and have no debt. And there is nothing wrong with that but are they making their money work efficiently for them? It is a personal choice at the end of the day.
Buy to let is now a specialist mortgage area. Many brokers won’t deal with this so it is important to make sure that yours does, and is independent and whole of market to make sure you get the best deal.
The recent tax changes mean that most new buy to let lending is being done via Ltd Companies. For all landlords, especially portfolio landlords, it is important to seek advice from a tax specialist on how these tax changes will impact on you.
In September 2017, the Prudential Regulation Authority (PRA) introduced new rules for landlords with four or more buy-to-let properties. They now have to satisfy different criteria to secure mortgage borrowing, as they are considered as ‘portfolio investors’.
To comply with the new portfolio landlord underwriting standards, lenders are now looking at the total income versus borrowing across all a landlord’s properties, to ensure that any new borrowing doesn’t adversely affect affordability for other properties within the portfolio.
This means more work for lenders, who will have to investigate each mortgaged property held by the landlord in more detail, then apply an Interest Coverage Ratio (ICR) across the portfolio. This ICR will vary, depending on the individual lender and the number of properties owned with a mortgage.
In addition, in some cases, the lender will also take into account the landlord’s individual earned income/salary. This may mean you can borrow more or less if you don’t have income to support voids.
The impact of the increased underwriting resource required to implement these measures meant that some smaller building societies withdrew from buy- to-let mortgages for investors with four properties or more. Specialist buy-to-let lenders are continuing to offer mortgages to both portfolio and non-portfolio landlords. Many of these only offer mortgages via mortgage brokers so talk to your broker when you need to look at this.
Most landlords will not be affected by the new portfolio rules. A survey carried out by the Strategic Society Centre in 2013, showed that 72% of private rented sector (PRS) landlords had just one rental property, with 12% owning three or more. A further survey of 1,071 landlords, carried out by YouGov on behalf of Shelter in mid-2015, found 59% had one buy-to-let, with 32% owning between two and four. This survey also revealed 45% of landlords owned their property/ies outright, with no mortgage borrowing, and a further 40% had a loan to value of 50% or less. As such, it’s unlikely that the buy-to-let sector will experience much disruption as a result of the new rules.
For those who own four or more properties, as well as those who currently have three and plan to buy a fourth, the change is likely to mean a more limited choice of lenders and products when they come to purchase or remortgage. But, realistically, only those who have highly-leveraged properties and are not seeing much cash flow need to be at all concerned.
What do the new rules mean for landlords:
If you already fall into the category of ‘portfolio investor’ or are planning to add to your portfolio and will therefore become one, these are some of the key considerations for you:
1. The application process takes longer – This means planning well ahead and making sure you allow three months or more for lenders to make the checks they need.
2. You may not be able to stay with your current lender when you refinance – Some smaller lenders, particularly building societies, have decided not to continue offering buy-to-let mortgages to portfolio investors in light of the extra work required to satisfy the new rules.
3. Most deals are only available via brokers so use an independent, whole of market broker.
If you have four or more properties, you may wish to contact your broker to find out:
• Where you stand with your current mortgage deals
• What steps you will need to take when you refinance
You will need to provide any new lender with much more detailed information than previously. This includes the following:
• A portfolio overview with details of all properties
• A Business Plan
• An Assets and Liabilities statement
• Personal income
As some of this may take time to secure and could vary slightly from one lender to another, make sure you ask your broker for a complete list of what you will need to provide as early as possible.
So if you have not carried out a buy-to-let portfolio review recently, now is the time to do so. Work with your tax adviser, mortgage adviser and wealth manager, if you have one, to assess your total level of borrowing versus assets and take advice on whether you might need to make any changes in order to reduce the likelihood of running into any difficulties securing mortgage finance in the future.
If you are an ‘accidental landlord’, for example letting only one property due to a change in circumstances, you won’t be affected by the new portfolio legislation, therefore it’s a case of continuing as normal for most.
If you are a portfolio landlord and have any concerns about the potential availability of finance for either a new mortgage or a remortgage, please get in touch with us and one of our advisers will be very happy to talk through your options.
What lies ahead for the mortgage market in 2018? Here are some thoughts:
There could be a rate rise later in the year, possibly by summertime. The economy has made a strong start, inflation has fallen and confidence is rising. All point towards a rise.
The home buying process will become more digitalised. Automated Valuation Models (AVM) for property valuations and real-time affordability checks will play a more significant part in buying a home.
Lenders will make further investments in technology to ensure they offer a seamless mortgage application process.
Brokers will continue to play an increasing role as the human touch is important for customers as, for most people, a mortgage is the biggest financial decision that they will ever make. Customers value face-to-face interactions with brokers. People can find a common ground, something computers can never do. Last year approximately 75% of lenders saw an increase in mortgage applications from brokers and the value borrowers place on advice from brokers is growing.
Stamp duty relief will help more first-time buyers get onto the property ladder, but may have a detrimental effect on the private rental sector as more people opt to own rather than rent a home.
April will be an important month for the buy-to-let sector. Landlords may see a greater impact on their net profit as the next stage of the reduction in tax relief is phased in this month. This may also prompt lenders to review their minimum rental cover requirements to ensure landlords can comfortably manage their mortgage payments.
Purchasing new buy-to-let properties through limited companies may become more prevalent amongst landlords serious about either entering the market or building their portfolio.
The landlord market will become increasingly professional as tax changes take effect, new tenancy agreements start to impact, and landlords and letting agents come to terms with the increased regulation of the letting market. The 3% Additional Dwelling Supplement (ADS) will continue to put off opportunistic new landlords but not those serious about this as a business.
Listen in on the Property Rugby Club Podcast as host Alan Nash is joined by our Managing Director and Mortgage and Protection Consultant, Gregor McMeehan, and Edinburgh Rugby’s Neil Cochrane as they discuss all things rugby and property. The podcast can be found here. (Contains link to external site)