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Buy-to-let properties – 5 things to know before investing


Buy-to-let properties – 5 things to know before investing

With rental prices seeing record-breaking increases over the past couple of months, many people are considering whether to invest in a buy-to-let property. The demand for properties to let is currently outweighing the supply, so investors may want to take advantage of this knowing that they should secure a good rental. Although property is often seen as a secure investment, there are a couple of extra steps and responsibilities that being a buy-to-let landlord entails. So here are the 5 most important things to know before you invest in a buy-to-let property.

1. Know the area

The first, most important aspect of investing in a buy-to-let property is to know the area you plan on buying the property in. While it might be appealing to choose a property based on price alone it’s important to invest in the right neighbourhood. For example, a property might look like a good investment on paper, however, if there is a lot of construction happening near the property or the property isn’t close to any good amenities it can limit how much you can potentially charge for rent. The opposite can also be true though as if you find a property in a neighbourhood with great access to amenities you can expect both the value of the property and the rental income to increase over time. The best way to know if a property is in the right location for your portfolio is to discuss it with an estate agent as they will have lots of local knowledge.

2. Buy-to-let mortgages

As most buy-to-let properties are purchased with a buy-to-let mortgage it’s critical to understand the difference between these and a standard mortgage. The first major difference is how much deposit you have to put down for a buy-to-let mortgage. Although standard mortgages can only require a deposit as low as 5% most buy-to-let mortgages require a deposit of at least 25%. So ensuring you have enough capital before investing is essential. You will typically also need an annual income of over £25,000. In addition to this, most mortgage lenders will not give out a buy-to-let mortgage to first time buyers. Due to the fact that it’s a more risky investment to become a landlord if you don’t already own a property of your own. 

3. Taxes

Understanding the taxes involved in a buy to let property is an area that requires a lot of research for buy-to-let landlords. This is because there are additional taxes that only affect landlords or second homeowners. For example in England, Wales, and Northern Ireland there is a 3% surcharge on stamp duty/Land Transaction Tax for buy-to-let properties, with the surcharge being an extra 4% in Scotland. Landlords also have to pay income tax on the entire rental income and can claim a 20% tax credit on the mortgage’s interest payments. Let’s give an example of how this works: If you earn £12,000 a year from rent and pay £4,800 in interest you can claim a tax credit of £960.

4. Setting up a company

An effective way to decrease your tax bill is to set up a limited company. It’s important to note that it isn’t beneficial for every buy-to-let landlord to have a limited company, especially smaller ones. If a property is purchased and owned by a limited company all costs associated with the property can be deducted as business expenses. Additionally, your company will get a more beneficial tax rate with the current rate being 19%. You can then withdraw your income from the company in the form of dividends of which the first £2,000 annually is tax-free. You will also need to take into consideration the capital gains tax you will have to pay should you sell the property for a profit.

5. Buy-to-let profitability

The final major determining factor for whether a buy-to-let property is right for you is to determine whether it is profitable. Most mortgage lenders will refuse to agree to a buy-to-let mortgage if it isn’t deemed sufficiently profitable. You can calculate your predicted rental yields by using this calculation;

  1. Take the yearly rental income of a property
  2. Divide this by the amount you paid for the property
  3. Multiply the figure by 100 to get the percentage

To get the most accurate picture you need to include all expenses and any void periods a property might have. If you pay the basic rate of tax you will want rental income to be 125% of the interest payments which rises to 145% if you pay the higher rate. If the rental income doesn’t meet these thresholds then it is unlikely that a mortgage will be issued.

Overall, the most critical pieces of information to know before investing in a buy-to-let property are knowing the area and understanding how mortgages and taxes work for rental properties. It’s also essential to figure out whether it’d be beneficial to set up a limited company and if the property is profitable.

If you are considering investing in your first buy-to-let property or are looking to expand your already existing portfolio please contact us here.

Thomas Allen