So you have found the type of property and location you are interested in, next you need to review the finances. There are effectively two separate components to consider here, one is the financing for the mortgage, the other is the cash flows and ultimately profit form letting.
For the mortgage you will need (in most cases) a buy-to-let mortgage and a quick google search will produce a seemingly unending list of mortgage brokers offering their services here. But you need to know the numbers will work, so here are the key metrics mortgage lenders will require:
LTV, the Loan-to-Valuation (or purchase price whichever is the lower). In the current market most products are either at 70% or 75% LTV, which means you need to fund a large deposit. You can raise the deposit from releasing equity elsewhere, but you cannot have a “second loan” for your deposit on a residential buy-to-let (it is different for commercial property, we will discuss this later).
The second metric used by lenders is the “rental cover”, typically this will need to be at least 125% of the mortgage interest payments. This is best explained by an example:
- Assume a £100,000 mortgage on your £135,000 property purchase price.
- Mortgage interest rate on the lender’s SVR of 5%
- With 125% cover the lender requires you to have 1.25 x 5%, e.g. 6.25% rental income on the mortgage of £100,000, thus you need to have rent of £6,250 per annum (£521 pcm)
- Thus for the £135,000 property you are buying you will need £35,000 deposit and a market rental income potential of £521 pcm.
One factor we do not mention here is that for any mortgage you will also need to show some proof of income and you will also need a good credit rating.
Next, the key part, the financials need to generate monthly cash flow and a rental profit. All too often newbie landlords focus on the gross rent and mortgage interest and assume that providing it generates a positive difference that it will be fine, wrong! There are key costs and loss of income to be considered in your financial calculation, these are as follows.
Rental voids, it is very unlikely you will rent your property for 12 months a year, every year. You need to budget for times when it is empty (rental voids), we suggest 1 month per year, or 8.33% of the rent. Next you need to budget for letting agents, even if you manage the property yourself you will need an agent to find a tenant (you could do it yourself but the agent will normally find a tenant much more quickly thus reducing rental voids). Letting agents will typically charge 10% (or more) + VAT, so that is another 11.75% of your rent. Finally there are maintenance and insurance costs (including service charges for flats which can be higher), it would be prudent to budget another 10% of your annual rent for this. In summary:
- Rental voids 8.33% of rent
- Letting agent 11.75%
- Maintenance 10%
- Total costs around 30% of the annual rent.
Now to make all of this work together, our example above suggests that you need to budget for at least 130% rental cover on your mortgage interest costs, and remember, today mortgage interests costs are quite low, so you are better off using expected future mortgage interest rate costs, no one knows for certain but a rate of 6% + seems more realistic. Thus you need to achieve a minimum market rent of £7,800 p.a. (£650 pcm) for a £100,000 mortgage on your £135,000 property investment.
Our next post in this series will cover managing the property and tenants.
