A beginners guide for “buy-to-let”

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Editorial Team
Published:
July 17, 2023
Last updated:
March 11, 2024
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Guidance

Buy-to-let can be stressful and time-consuming

In recent years, buy-to-let has lost much of its appeal. Property is no longer very appealing for investing due to various government policies.

Indeed, because of the narrowing profit margins caused by increased levies and the loss of tax assistance, many landlords have chosen to sell up and quit their businesses (more on that below).

As a buy-to-let landlord, you'll probably need to:

  • How to purchase the property, apply for a buy-to-let mortgage, which is more expensive than a residential mortgage.
  • Attend to phone calls regarding a flooded bathroom
  • Manage the needs and mishaps occurring on behalf of tenants
  • Paying a company to find renters
  • Buy-to-let investing may be quite risky, thus it should only be done by those who have a reserve of funds to cover unanticipated expenses. Additionally time-consuming, managing a home should not be considered a quick investment.

It's just the wrong type of investment for certain folks. Compared to real estate, stock market funds are a lot easier to manage, therefore we provide information on stock market investing for those without a lot of financial resources.

However, there is still money to be earned in buy-to-let, particularly in places with a high concentration of students and employees, which increases demand and, consequently, rent prices.

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  • There are new tax rules to learn

The government increased the stamp duty rate on second houses and buy-to-let properties in England, Wales, and Northern Ireland by 3% in April 2016.

The 3% fee is still due from landlords on the entire property. The 3% stamp duty increase amounts to an additional £12,000 if you purchase a rental apartment for £400,000.

This fee is already an addition to the standard stamp duty rates that we have listed below.

Second-home owners and buy-to-let landlords in Scotland are required to pay an additional 4% in stamp duty.

More tax changes have also affected buy-to-let investors.

Private landlords had access to mortgage interest tax relief, which allowed them to deduct mortgage interest payments from their rental income when determining their tax obligations, until April 2020.

Buy-to-let landlords are now required to pay income tax on ALL rental income, regardless of how much of it is used to pay mortgage interest.

A new 20% tax credit on interest is available to landlords. As a result, the move is neutral for the majority of people in the lowest tax rate (some will lose out though by being pushed into the higher tax bracket because of the new way tax is calculated).

However, landlords who pay income tax at a rate of 40% or 45% end up paying far more now than they did previously.

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  • Calculating buy-to-let tax

Assume that you receive $1,000 per month in rental revenue and pay £400 per month in mortgage interest. Other costs that can be deducted from taxes are not considered.

  • £12,000 is the annual rental revenue.
  • Interest paid annually equals £4,800
  • yearly rental income tax:
  • 20% tax would cost you $2,400.
  • 40% tax equals £4,800 if you pay it.
  • Tax credit on interest is £960 (20% of £4,800).

Your tax obligation is as follows:

  • Taxpayer at the basic rate: £2,400 - £960 = £1,440
  • Higher-rate taxpayer: £3,840 ($4,800 minus £960)

Prior to April 2020, the following tax regulations allowed both owners to deduct their interest payments from the rental revenue before computing their taxes: £12,000-£4,800 = £7,200.

Similar to the current system, the lower-rate taxpayer was required to contribute £1,440.

However, the higher-rate payer paid about £1,000 less ($2,880) than they did, therefore they are the ones who have been most negatively impacted by the new system.

Keep in mind that these numbers must be reported on a tax return.

  • First-time buyers might not qualify

Theoretically, first-time purchasers may obtain a buy-to-let mortgage. But in practise, it's really challenging since lenders frequently view this group as being too hazardous.

You won't have as many mortgage options, so you'll probably need a larger down payment to get a fair bargain.

The lender will carefully consider your circumstances and the reasons behind your decision to acquire a buy-to-let property even though you have never had a house of your own.

  • Not all properties are profitable

To qualify for a buy-to-let mortgage, you must show that renting out the home would be lucrative.

How to figure out rental yields

  • Consider a property's yearly rental revenue.
  • Subtract this from the purchase price of the property.
  • Calculate the percentage by multiplying the value by 100.

You may use a rental yield calculator online to help you understand all of this information.

Don't forget about the costs of upkeep and insurance, any managing agency fees, mortgage interest, and potential vacant periods for the property. The rental return will be reduced by all of these expenses.

You'll also need to demonstrate that even if interest rates rise, you can still make mortgage payments.

If you pay taxes at the basic rate, the rent must equal 125% of the interest, or around 5.5%. For individuals in the higher tax rates, this increases to 145%.

If you sell the home, a buy-to-let is also liable to capital gains tax.

This is charged at the following rate:

  • higher-rate taxpayers will pay 28%
  • Basic-rate taxpayers pay 18%

If you are a basic rate taxpayer, the gain will be added to your income, which may cause you to fall into a higher-rate band.

Conclusion:

Buy-to-let can be a profitable expenditure or a costly burden, but it is all determined by how the investor is managing and deciding what, where, when, and how they buy and let their properties. Despite that it gets progressively harder in terms of supply, price, locations, and limitations, this also opens doors to a potential of incredible demand and market for tenants that can be attained and expanded upon.

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