Be a buy-to-let success

The housing market may have suffered a slight chill recently, but the buy-to-let (BTL) mortgage market is still hot – thanks in part to something that might be expected to put off potential landlords: interest rate rises.

Increases in mortgage rates have made potential buyers wary of venturing into property ownership, creating a surge in demand for rental property, according to Paragon’s latest Buy-to-Let Index. That demand has also pushed up rents: average rental income was up by 7 per cent in the 12 months to September.

“We’re certainly not seeing any reduction in demand,” says Andy Wiggans, director of mortgage products at Mortgage Express. “Our recent BTL seminars in Leeds, Newcastle, Birmingham and London were very well attended by people keen to get into this market.”

Even so, those interest rate increases – three in the last 10 months [since January 2007] – have taken their toll, making BTL loans more expensive. Lenders are also becoming more choosy about who they loan money to. “In the current unstable economic environment, lenders are reducing their risk by handpicking the best customers,” explains Nigel Terrington, chief executive of Paragon. “There are reports that the number of rejected mortgage applications has risen by 60 per cent in the past six months.”

Wiggans notes that some loan-to-value (LTV) ratios have come down, too, making it harder to borrow big sums without a sizeable deposit.

Escalating costs

Even successful mortgage applicants are likely to notice fee increases: 2.5 per cent is now standard among many BTL lenders, while Paragon’s fees top out at 5 per cent of the sum advanced. On a £150,000 mortgage, that’s an eye-watering £7,500.

Lenders, unsurprisingly, don’t think these fees are any deterrent. “Lots of people have got very excited about fees recently, but higher fees are often balanced out by lower pay rates on the mortgage,” says Andy McQueen, managing director of Nationwide’s specialist lending arm UCB. “If you need a pay rate of 4.99 per cent to make your loan affordable, it’s worth paying a higher fee for it rather than paying a lower fee for a loan with a higher interest rate.”

Arrangement fees can be set against taxation of the rental income, as can mortgage interest and property repair costs.

McQueen believes BTL is still a viable alternative to equities and pensions when it comes to retirement. “If you go into it with your eyes wide open, it’s still a great investment, especially if you’re planning to hold the property for the longer term,” he says.

Paragon’s Buy-to-Let Index bears this out: average total return (rental yield plus increase in property value) on BTL property held for 12 months is now 14.2 per cent, up from 10.5 per cent in September 2006. This compares very favourably with the 9.1 per cent return enjoyed by the average UK equity income fund in the 12 months to August 2007 [Lipper].

Rules and regulations

Both Wiggans and McQueen advocate doing extensive research before foraying into this market, however, and Wiggans reckons there is nothing more valuable than a local letting agent. “Their knowledge is worth its weight in gold, and they can also help with other issues such as rules surrounding deposits and certificates,” he says.

Since April this year, all private landlords have had to register with a tenant deposit scheme (TDS). These basically prevent landlords from holding on to all or part of a tenant’s deposit at the end of the tenancy for no good reason. There are three government-approved TDSs run by the Dispute Service, an independent, not-for-profit organisation.

Landlords also need to insure their building and its contents (if the property is let furnished) and comply with specific legal requirements on safety. Issues such as damp, faulty electrics, poor security and noise levels are all assessed by local councils under a ratings system if a tenant complains. If there is a serious problem, you can be forced into making repairs or renovations. You will need an annual gas safety certificate, even if the gas supply only consists of a capped pipe, and all furnishings and fittings must meet fire and safety regulations.

Certain types of property in some areas may also require a licence before you can let them out – any property of at least three storeys housing at least five people has to be licensed, for example. The local authority in your chosen rental area will be able to advise whether a licence is required for other property types.