Buy-to-let: nine things you need to know | MBD
Many people dream of the world of buy-to-let. However, being a landlord is not an easy job.
This article will cover nine important facts about buy-to-let.
It can be stressful to buy to let.
Learn about new tax rules.
A limited company can help you save money.
A large deposit is required to get a mortgage.
First-time buyers might not qualify.
Profitable properties do not all exist.
Mortgage fees can be very high.
You should think twice about cashing in your pension to purchase the property.
Be sure to know where you are located.
It can be difficult and time-consuming to buy-to-let
In recent years, the luster of the buy-to-let property has declined significantly. Property is now less appealing as an investment due to a variety of government policies.
Many landlords are selling up as the new fees and loss of tax relief have reduced their profit margins.
You will need to be a landlord of buy-to-let properties.
- To purchase the property, you can apply for a buy-to-let mortgage. This mortgage is more expensive than a residential mortgage.
- Respond to calls regarding a flooded bathroom
- You may have to deal with a nightmare tenant
- Tenants need to be found by an agency
Buy-to-let investing can be risky and should only be done by people who have the financial resources to cover any unexpected costs. It can be time-consuming to manage a property, so it should not be considered a short-term investment.
It may not be the right type of investment for everyone. Stock market funds are much easier to manage than property. Learn how to invest even if you don’t have a lot of money.
However, buy-to-let is still a viable option, particularly in cities where students and workers return. This drives up rent and increases demand.
You can learn new (ish) tax regulations
April 2016 saw the imposition of a 3% stamp tax surcharge on second homes in England, Wales, and Northern Ireland.
The 3% surcharge is still payable by landlords on the entire property. The 3% stamp duty surcharge is an additional PS12,000.
This surcharge is in addition to the normal stamp duty rates, which are described here.
Stamp duty is an additional 4% that second-home owners and landlords of buy-to-let properties in Scotland must pay.
Tax changes for buy-to-let investors are also more severe.
Private landlords were able to deduct mortgage interest payments from rental income until recently. This was known as mortgage interest tax relief.
However, landlords who own buy-to-let properties have been required to pay income taxes on their entire rental income since April 2020, regardless of how much mortgage interest is taken.
A new 20% tax credit for interest can be taken advantage of by landlords. This rule will neutralize the tax change for most people in the basic tax bracket. However, some will be pushed into the higher tax bracket by the new tax calculation.
However, landlords that pay income tax at 40% and 45% will now be paying much more than they did before the shakeup.
Calculating the buy-to-let taxes
Let’s say that monthly rental income is PS1,000, and mortgage interest payments are PS400. Other expenses can be deducted from tax.
- Annual rental income = PS12,000
- Annual interest paid = PS4,800
Taxes on rental income annually
- You pay 20% tax = PS2,400
- You pay 40% tax = PS4,800
- Interest tax credit (20% of PS4,800 = PS960
You will be responsible for the tax bill
- Basic-rate taxpayer: PS2,400 – PS960 = PS1,440
- Higher-rate taxpayer: PS4,800 – PS960 = PS3,840
Both owners could deduct interest payments from rental income under the old tax rules prior to April 2020.
Lower-rate taxpayers had to pay the same amount as under the new system — PS1,440.
However, the higher-rate payers paid almost PS1,000 less — PS2,880 — so these are the ones who really have been affected by the new system.
A limited company can help you save money
You might consider purchasing a property to rent through a limited company if you don’t mind paying more tax on rental income.
You should seek expert advice before you make such a big decision.
If the property is owned and managed by a company all costs, including mortgage interest payments can be deducted from business expenses.
Profits are subject to corporation tax. The current tax rate is 19%.
Dividends are a way to make income as a landlord.
The first PS2,000 in dividends will be exempted from tax in 2021-22. However, you’ll have to pay tax for any subsequent withdrawals.
- 5% for a basic rate taxpayer
- 5% for those who fall within the higher-rate bracket
- 1% for taxpayers at an additional rate
Also, capital gains are a consideration. If a property is being sold at a profit, the corporation will be subject to corporation tax. If you withdraw the money, you will have to pay income tax.
A company has the advantage that you can only take out money when it suits you. This could happen if your other income is low, or if you go on a sabbatical.
A large deposit is required to get a mortgage
A standard mortgage can be secured using a deposit of as low as 5%, but a buy-to-let mortgage requires a minimum of 25%.
In order to be considered a professional, you must also earn at least PS25,000 per year.
Learn more about buy-to-let mortgages in our guide to buying your second home. Use our Mortgage Comparison Tool to help you find the right mortgage for your needs.
First-time buyers might not qualify
First-time buyers can get a buy to let mortgage in theory. It’s actually very difficult as lenders are often too cautious with this group.
You will have fewer mortgages available to you, so you’ll likely need to deposit more to secure a great deal.
Lenders will carefully examine your financial situation and the reasons you wish to buy a property for rent.
A mortgage broker can help you find a lender who welcomes first-time buyers.
Profitable properties do not all exist.
To be eligible for a mortgage on a buy-to-let, you must show that the rental of the property is profitable.
How to calculate rental yields:
- Consider the annual rental income for a property
- Divide this amount by the price you paid for the property
- To get the percentage, multiply the number by 100
Remember to include maintenance, insurance, managing agent fees, mortgage interest, and any periods when the property may be vacant. These costs will reduce the rental yield.
Also, you will need to prove that you can pay your mortgage even if interest rates rise.
Basic-rate taxpayers pay 125% rent. This is calculated at a rate of around 5.5%. For those in higher tax brackets, this rises to 145%
Capital gains tax is also applicable to a buy-to-let property if it is sold.
The rate is:
- 28% for higher-rate taxpayers
- 18% for taxpayers at a basic rate
If you are a taxpayer at the basic rate, this gain will be added to your income. This could help you move up to a higher-rate band.
Mortgage fees can be very high
Buy-to-let mortgages may have higher interest rates and fees than a standard mortgage.
Keep in mind, however, that not all buy-to-let mortgages fall under the Financial Conduct Authority’s (FCA) supervision.
These mortgages usually come with interest only. While your monthly payments may be lower than a repayment mortgage, you won’t actually reduce the debt.
These mortgages can be advantageous because you have the option to pay off a portion of your loan every year if your rental income is higher. Be sure to check for penalties fees, especially if your fixed rate is applicable.
Remortgaging interest-only loans after a period of time or when the fixed-rate has ended is another way to handle them.
This option may appeal to you, but you will need to pay more, be older, and there is no guarantee that the numbers will still add up, especially if interest rates rise.
You can eventually sell the property to repay your mortgage. If house prices drop and the proceeds aren’t enough to cover the outstanding debt you will be in negative equity. You may need to make up the difference by yourself.
It’s worthwhile to build up a financial cushion in order to ensure that your property empire does not collapse.
Before you cash your pension, think twice
Be careful if you’re thinking of cashing in your pension to buy a property.
If you take out your pension, only 25% will be exempt from tax. The rest will be subjected to income tax.
You will have to pay:
- Stamp duty will be charged on any property that you purchase
- Rent income subject to tax
- Capital gains tax is also applicable if you decide to sell
Inheritance tax will apply to the property if it is left to your family members after you have died. Normally, inheritance tax is not applicable to your pension.
Get to know the area
If you are looking for a cheap two-bed apartment in the northeast, it might be tempting. Be aware that not knowing the area can result in serious losses.
There could be a weakening or declining demand for rentals in this area. The ban on most letting fees may have caused estate agents to flee the market, making it more difficult for you to rent the property.
If you decide to sell your property, you might find yourself taking a loss.
Do your research, then continue to do more.
You should also consider the demographics of potential tenants: Is there a demand for young professionals, families with young children, or students?
This will also determine the type of property that you buy to let.