Choosing A Lender
Gerry Fitzgerald has built a multi-million pound property portfolio which he manages himself. As a former Independent Financial Adviser he is further qualified to offer insight and guidance on the buy-to-let mortgage market. With long experience, both of using letting agents and of managing properties himself, he can speak with authority on the benefits and pitfalls of both approaches. He also runs a successful holiday letting business.
With the default rate of buy-to-let (BTL) mortgages lower than that of residential mortgages and with interest rates higher, the BTL market has proved a remarkable success story for lenders. As a result, competition for this business has increased greatly in recent years with more and more lenders offering a BTL product range. How do you choose between them?
MAINSTREAM OR SPECIALIST
For most high-street lenders, BTL is an add-on. Their core business remains residential mortgages for owner occupiers. For that reason, when it comes to BTL, they tend to be unduly restrictive in one way or another. For example, a lender may insist that some element of personal income, in addition to the rent, be taken into account when calculating the mortgage to be offered. Others may lend only to 80% or 75%. Some will limit to just a few the number of BTL properties you may purchase or put a cap on the total value of your portfolio. Few will help you if you have had any credit problems in the past. All will be considerably less generous in their calculation of the maximum mortgage you can have. For the serious investor the specialist lender remains the best choice.
Most lenders will not offer a BTL mortgage to a first-time buyer. They expect you to have your own residential mortgage already. Only one or two will consider first-time buyers. It is vital to check this point with the lender, directly or through a broker, before embarking on a decision in principle request (see Chapter 10) or full application. You will not only be wasting your time but you will also leave too many footprints on your credit file (see Chapter 10).
Surprisingly, the lowest rates are not generally best for the BTL investor, for they usually come with unacceptable conditions. A particularly low initial rate, for example, may tie the borrower in for a number of years after the rate has changed back to the higher variable rate. Changing to another lender during this ‘extended tie-in’ will incur a hefty penalty. In addition, as we shall see, choosing the lowest rate available always means sacrificing the maximum mortgage available. For most investors the priority is to borrow as much as possible.
These vary widely from lender to lender. All have an arrangement fee (which can be added to the loan), but this fee can range from a few hundred pounds to as much as 1.75% of the amount borrowed! Because it is added to the loan (few choose to pay it up front), there is a tendency to disregard it. It is, however, a very costly add-on as interest is also paid on this amount for the duration of the mortgage.
In addition to the arrangement fee (sometimes called a completion fee), some lenders charge a ‘mortgage indemnity guarantee’ fee, or MIG. This is essentially an insurance premium paid by the borrower, but for the sole benefit of the lender. If the lender repossesses the property but fails to recover the full mortgage amount on resale, the insurance company will pay the lender the difference (the insurance company can then legally pursue the hapless borrower to recover the sum it has paid out!).
Most lenders agree that the rent should exceed the mortgage interest (not capital and interest) by a certain amount. But they differ on two important counts – the definition of ‘interest’ and the margin by which it should be exceeded.
For most lenders the ‘interest’ is not the rate you pay (which may be quite low initially) but the standard variable rate (much higher) charged by the lender. A few lenders, however, base the calculation on the pay rate. Since this will normally be lower than the variable rate, the mortgage available is correspondingly higher. In addition, some lenders require the rent to be 130%, others just 125% of the mortgage interest. A few will come down to 115% or 110%. Choosing a lender with the right formula is crucial if you want the maximum mortgage possible.
Specialist BTL lenders are aware that this may not be the only purchase the borrower will make. Some will accordingly offer a drawdown facility to help in future transactions.
The principle here is that the lender will advance up to a certain percentage (typically 85%) of the property value. If the property has increased in value since the purchase a lender who offers a drawdown facility will allow the borrower to drawdown (i.e. borrow further funds for a deposit on further property purchase, repairs, etc.). The only proviso is that the rent is sufficient to meet the lender’s criteria for the advance (see above).
This has very significant benefits for the serious investor. For a start, there is no need to spend time and money on remortgaging with another lender. In a matter of days and with a minimum of fuss the funds are transferred to your bank account. If you are buying abroad or at auction and need to buy for cash, this facility is invaluable. Lenders who don’t offer this arrangement should be avoided.
LIMITED COMPANY MORTGAGES
Few lenders will offer BTL mortgages to limited companies. Of those who do, most require that a new company be set up solely for this purpose (an SPV, or special purpose vehicle). Only a tiny number will allow an existing company to borrow.
When the BTL mortgage was first introduced, lenders were extremely cautious. Apart from restricting the maximum loan to 75% of the property value, they also refused to consider altogether certain property types. These were ex-local authority properties, studios and flats over commercial premises. The reasoning was quite simple. If the borrower defaulted, the lender would have to sell the property. Such properties were considered difficult to sell (ironically, tenants love them!).
Initially, both flats and houses were excluded. Now, however, houses are accepted by all lenders. In the case of flats, there is still a problem. This applies, in particular, to tall blocks of flats and to blocks of a certain construction. Most lenders will still not consider apartment blocks of more than five storeys, regardless of which floor the flat in question is on.
In the 1960s there was a popular method of construction for local authority apartment blocks involving an external cladding of concrete slabs, now considered unsafe. Blocks with this feature are still unacceptable to most lenders.
Once regarded as the Cinderella of the property world, studios are now widely accepted. They must, however, be large and in very good condition.
This particular problem has eased but has not disappeared. Many lenders will not entertain a mortgage on an apartment over any kind of commercial premises. Those who do (just a few!) are very specific about exclusions. These are: no launderettes, no dry cleaners, no restaurants, no take-aways, no hair salons. The one thing in common with this list is smell. Chemicals and cooking odours do not appeal to potential buyers. BTL lenders won’t touch them.
It follows from the above that, if the property you have your heart set on fits into this list of undesirables, you will have to be absolutely certain there is a lender out there who will accommodate you. It is also worth bearing in mind that you will, one day, want to sell this property and your potential buyer will face the same problems.
It is common for builders and developers to offer incentives to potential purchasers. This can take various forms, such as a discount on the price, cash-back after completion or help with the deposit. Unfortunately most lenders are uncomfortable with these arrangements. In essence they suspect that the value of the property is really less than the asking price, which has been artificially inflated to allow for the incentive.
Where there is a straight discount, therefore, most lenders will simply knock the discount amount off the price and offer a mortgage based on the lower figure.
In the case of a cash-back the price remains the same and a cash refund is made on or after completion. The outcome of this arrangement depends on whether the lender is aware of it. It is quite common for the offer letter (see Chapter 10) to require the purchaser’s solicitor to inform the lender of any form of cash incentive. A lender informed in this way is likely to treat the arrangement as a discount by another name and deal with it as outlined above.
Help with the deposit is more likely to meet with success, with some lenders at least. Here the rule of thumb is to allow a maximum of 5% contribution from the builder. In other words, the purchaser is expected to find the remaining 10% of the 15% deposit. Only the true niche lender will accept a different formula or accept that the buyer will not provide any cash of his own at all.
If you are buying a new-build property or buying off-plan, you may well encounter this problem. A lender should be chosen with this in mind from the outset. Otherwise the problem will surface late in the transaction and could well result in the mortgage offer being withdrawn or altered in an unacceptable way.
If you have had problems securing credit in the past and are aware of such matters as defaults or county court judgments on your credit file (see Chapter 10), you need to choose a lender who does not have a problem with this and can offer a choice of adverse products. As the lender will get all the details from your file in any case, you will simply be wasting time. If you are using a broker you should make him aware of this at the outset so that he can source the appropriate lender immediately.
For a list of specialist BTL mortgage lenders, see ‘Useful addresses’.