Financing your property investment
We hate to be the one’s to break it to you, but buying property as an investment costs money. And we’re not just talking about the mortgage. There are other costs and expenses associated with buying and letting. All of them have to be added into the sums you should be doing on every property you buy.
The basic principle that most experienced landlords follow is this:
- The income from rental should cover the average annual cost of buying and maintaining the property.
- Effectively this means that the tenant pays for the property.
- The profit in the deal comes from capital growth – not from rental income.
- One day you will sell the property and realize a handsome profit.
But if you underestimate the annual cost of buying and maintaining your property the deal won’t “stack up”. You will end up subsidizing the property, and if, like us you’ve already got one big mortgage on your home to worry about you really won’t want to be coughing up on another. Worst case is that you will decide you can’t afford the monthly cost and be forced to sell up at a loss
Don’t let that happen. Take all the costs into account when you do your sums on a potential property investment. Here are the main costs to consider:
Obviously this is your single biggest monthly cost on the deal. So for goodness’ sake shop around!
Most lenders want a considerable deposit on buy to let mortgages. Typically they limit their lending somewhere between 75 and 80 percent loan-to-value (LTV). The widest choice of deals is available to borrowers with 25 percent or more to put down, so if you want the best rates or the most flexible terms you need to be on a bigger budget.
The more deposit you can afford, the better your mortgage rate, the more likely it is that your rental income will cover your monthly costs.
The three most popular types of mortgage for buy to let investors are:
- Fixed rate deals. This type of mortgage allows you to plan ahead because you can be sure how much your outgoings will be each month.
- Discount mortgage. The rate you pay is variable (so big interest rises by the Bank of England can still hurt you) but the discounts on offer are greater than with a fixed rate.
- Flexible and Current Account mortgages. These are becoming increasingly popular with landlords. Ability to overpay and underpay give flexibility to get ahead on payments when times are good, and extend your borrowing when times are tough e.g. if you are landed with a big repair bill.
Finally on buy to let mortgages, remember to keep shopping around – especially when your fixed rate or discount deal comes to an end. Paying too much for your mortgage is perhaps the worst crime a buy to let landlord can commit.
Valuation, conveyancing, stamp duty, etc.
As with a home purchase, buy to let properties have to be valued so that both you and your lender are happy with the deal. But in this case they will also want an assessment of rental income.
All the other costs associated with buying a home need to be taken into account: conveyancing, stamp duty etc.
And if you are paying a property finder to locate investment properties for you, remember to include their finder’s fee in your sums – normally between 1%-3% of the purchase price..
Owning and letting
Refurbishment and Furnishing
If you’re buying an older property budget for the cost of refurbishing it before letting. This should include the cost of any tradesmen that will be involved. Do you know the cost of re-wiring? Installing a shower? Re-plastering? Re-carpeting?
These need to be in your sums right from the start. Spending over the odds on making the property ready to rent can kill your deal.
Also budget for furnishing the property. Tenants in a furnished let need everything from curtains to teaspoons. Some companies now offer furniture and furnishing packs starting from around £1,000 this can be very convenient – especially if your property is in a different part of the country.
One of your big decisions is whether to use a letting agent or not. This really hinges on how ‘hands on’ you are prepared to be. If you do more of the letting and management of the property yourself you keep more of the rent – safeguarding your profitability.
On the other hand there are advantages in having someone else in charge of the day-to-day running. For example, you won't be hassled by requests from tenants or have to chase overdue rent.
Pay more and the agent will find the tenants for you. They know where to advertise and will be up-to-speed on things such as running credit checks and preparing inventories.
The only downside is the drain on your profit - you should allow between 10 and 15 per cent of your rental income to cover agency fees.
Even the most successful landlords experience periods where they have no tenants, and with no rent coming in you have to find funds to cover the mortgage payments.
Make sure you have the cash reserves to cover the cost of your mortgage if you find yourself with a void. You should also have a source of emergency funds in case you need emergency maintenance on your property.
You will need annual buildings insurance and contents cover if you let the property furnished. You’ll need specialist landlord insurances so it’s more expensive than you usual home insurance policy.
You can also take out protection against voids in tenancy. Check out what’s on offer to see if it’s worth the extra expense.
Remember, profits on rental income get taxed as personal income. You can offset expenses against this (including mortgage interest).
Help with tax matters from an accountant might also be a sensible cost to add into your investment sums.
Putting it all together
Blimey! That sounds like a lot of cost to consider: mortgage, valuation, conveyancing, stamp duty, refurbishment, furniture, agent’s fees, emergency funds insurance and income tax.
Before you put in an offer on a property you have to do your research. Balance the rental income you can expect (less an allowance for voids) against all the costs of buying and owning a property.
Does your deal “stack up”?
If so, go for it – you’ve got a good chance of capital growth and a handsome profit in a few years time. There are many property investors who have been successful at buying great buy to let property investment deals that stack up. Have a look at our property investment deals to make sure that you start with the right properties.