A gold mine? In your dreams

Soaring house prices and rising interest rates have made life more difficult for prospective buy-to-let investors. In London and the south east in particular, rental yields have been falling while the cost of borrowing has risen.

This has prompted some lenders to revise one of the key criteria on which they base a buy-to-let mortgage offer. When lenders are assessing an application, they look at where the property is, the experience of the prospective landlord, what rent can be charged and how comfortably that covers mortgage payments.

Normally lenders require monthly rental income to cover the mortgage by between 125 and 150 per cent. Put another way, if you are paying £500 a month towards a mortgage, your tenants need to be paying you at least £750 in rent.

Until now, lenders have been using their standard variable rate (SVR) to calculate this margin between the rent and the mortgage. But as interest rates have risen, rents have not. SVRs tend to be much higher than the discounted, fixed or capped rates that lenders promote as special offers. So over the past few weeks some lenders have been using, rather than the SVR, a lower interest rate that allows them to increase the maximum sum applicants can borrow.

They say this is because there are so many discounted and fixed offers around that few buy-to-let borrowers actually pay the SVR. But this raises questions about how responsible it is to relax lending rules at a time when house prices appear to be peaking and interest rates look set to rise further.

Jane Dawson, acting editor of Business Moneyfacts, an independent money advice service, says: 'When lenders work out mortgage payments, they are not necessarily taking into account the rate the applicant is paying, but instead use the SVR or a notional rate of interest. Over the past few weeks we've seen lenders lower their notional rate, and this lowers the rental requirement. For example, if previously the notional rate was 6.15 per cent, they might now be using a rate of 5.95 per cent when assessing applications. This increases the amount someone can borrow.'

She says that as property prices have risen but rents have remained stable, it has been more difficult for prospective landlords to buy property using the old requirements for rental income. 'Lenders have reduced the cushion between the rent coming in and the mortgage payments.'

However, she says lenders are still quite careful about who they lend to, because the buy-to-let market is relatively new and there is no history of repossession rates.

Simon Jones, director of Savills Private Finance, spends a lot of time talking to lenders about prospective buy-to-let investors. 'Clearly with interest rates rising, it is putting pressure on yields, particularly in London and the south east,' he says. 'Outside London it is easier to make the calculations work.'

One lender that has reduced its notional interest rate is Birmingham Midshires. It no longer uses its standard SVR of 6.15 per cent, but bases calculations on the Bank of England base rate plus 1.95 per cent.

But Jones doesn't believe all lenders will follow suit, particularly if applicants are inexperienced landlords. 'An investor going to a lender directly and asking them to take a view or make an exception will probably be told that he or she doesn't meet the criteria. But if you are experienced, own more than two properties and have been doing this for more than two years, a lender may take your track record into account, particularly if you go through a broker.

'If you have been in the business, you have seen rental voids, been used to tenants renewing contracts and probably aren't as heavily geared as new entrants would be.'

Even so, he counsels against thinking that buying to let is a source of instant riches. 'It is not easy to make quick money - in fact it is almost impossible, and you need to have a proper strategy for the long term.'

Colin Dale at Skipton Building Society agrees that becoming a landlord is not a gold mine: 'It's an investment that you need to view in a five- to 15-year plan, and be prepared to ride out the whole cycle of the property market. There is still a perception that it's the way to make a quick buck, whereas in fact most professional landlords look for capital growth over the long term.'

Skipton is one of the lenders that has recently changed the basis on which it calculates rental income requirements. Skipton's SVR is 6.09 per cent and Dale says this level was 'becoming unrealistic and we were finding it difficult to attract the right type of customer'.

He adds: 'A lot of people are on a two- or three-year discounted deal and weren't ever going to be paying the full market rate. However, buy-to-let is definitely a risky proposition and lenders need to have a buffer - we ask for 150 per cent premium in terms of rental income. Some lenders have been asking for 125 per cent because they think they won't get the business if they ask for a higher premium, but we want the quality end of the market.

'London and the south east are more saturated and there is more risk to take on, while up here [in Yorkshire] the market is still active.'

A place in the sun for rent


Holiday-let properties may be a better investment than residential rentals, according to accountant and financial adviser Grant Thornton.

Kevin Hines, of GT's property and construction group, says: 'With falling rents and hefty exit costs, buy-to-let may not necessarily be the most effective option [to ride the property boom].

The accountant calculates that a cash investment of £57,500 (at 5.5 per cent interest-only) in a holiday let bought for £230,000 could produce an annual return of 15 per cent before tax.

The Inland Revenue classes a property as a furnished holiday let if it is available at least 140 days a year and let for 70 days.

Do's and Don'ts


1. Do your sums and take into account agents' fees, service charges, void periods, maintenance and insurance
2. Don't regard being a landlord as a way to make a quick buck 3. Do be prepared to hold your property for at least five years and remember that it is an illiquid investment
4. Don't overstretch yourself, particularly if you have never been a landlord before
5. Do ask yourself whether it is a sensible investment at this point in the housing market cycle and whether you have the patience to wait for the property to appreciate in value. House prices have already risen sharply and rental yields can be as low as 4 per cent in some areas - less than you would receive in interest from a deposit account.