Beware the buy to let mortgage trap

House prices

With interest rates set to increase to 5.75pc this week, buy to let investors should beware of a potential mortgage trap as their fixed rate mortgage terms come to an end.

Those who arranged two or three year fixed rate mortgages for around 4.5pc two years ago are soon to see their monthly payments rise considerably as they are forced to renew their buy to let mortgages at around the 6pc level.

A £150,000 interest only mortgage payable over 25 years costs £560 per month at 4.5% but rises to £750 per month at 6pc – a £190 per month increase.

This interest rise will not only affect your margins on your buy to let investments, it can also limit the amount that you can borrow when re mortgaging and this is the hidden problem awaiting many investors.

Rent versus mortgage payment ratios

With buy to let mortgages, the loan to value (LTV), whilst important, plays a secondary role to the ratio between monthly rental income and monthly mortgage payments.

Although there has been a general relaxation in the ratios required by lenders, most banks and building societies stipulate that the monthly rent must cover 125pc of the monthly mortgage payment.

Some lenders, such as the Scarborough Building Society also factor in additional void periods – three per year, further reducing the amount that they are prepared to lend against rental income.

Rents are not rising as fast as mortgage interest rates

Unfortunately rents are not rising as fast as mortgage interest rates at the moment. This means that when a buy to let investor seeks to re mortgage the rent/mortgage ratio could reduce the amounts that lenders will be willing to offer.

Using our mortgage example above, to maintain the rent/mortgage ratio, the buy to let investor would have to increase the rent by £190 per month, matching the mortgage increase, so as to borrow the same amount when re mortgaging at the end of the fixed rate term.

Should the worsening rent/mortgage ratio limit mortgage amounts, then the investor will have to fund the difference between the old mortgage and the new re mortgage from his own pocket, or be forced to sell the property.

Lenders might listen

If you have a good record of buy to let investing and have built a strong relationship with your existing bank or building society, they may well waive their rent/mortgage ratio requirements, particularly if you have a favourable LTV.

Re mortgaging with your existing lender may be the answer to avoiding the buy to let mortgage trap, however your current lender may not be offering the most competitive rates, squeezing your margins further.

Using a mortgage broker who knows you and trusts your abilities as a buy to let investor may well be able to discuss your requirements with a number of lenders, however they may encounter vigorously applied lending rules, just as you would.

Buy to let challenges

If forthcoming interest rate rises trigger a rise in re-possessions and defaults, banks and building societies will tighten their lending rules further, making it more difficult to resolve the buy to let mortgage trap.

Buy to let investors will have to work hard to renew their mortgages at the best rates as well as maintain their LTV's at manageable levels.

Yet another challenge for the investor in times of rising interest rates.

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