The buy-to-let jargon buster
Thursday 19 January 2017
So, you want to be a landlord? It’s a common investment choice – with about two million private landlords renting out somewhere in the region of five million properties across the UK – so you’re in good company.
There are, however, some things you really ought to know about investing in property. There are terms that you will come across that could catch you out if you’re not careful. It pays – literally – to not be in the dark about the jargon associated with housing market if you are to make money from buy-to-let.
Here’s our guide to help you see through the jargon and feel confident about your property investment(s).
Buy-to-let mortgage: What do I need to know?
The term ‘buy-to-let’ refers to any property bought with the aim of renting it out to a tenant. A ‘buy-to-let mortgage’ is the type of mortgage you can take out with a bank to purchase a property for this reason. These are common financial products and a good way to make your investment.
There’s just a few things you need to know about buy-to-let mortgages before you begin. Namely:
• You might struggle to get a buy-to-let mortgage if you don’t already own your own home (whether that’s with a mortgage or not)
• You’ll probably need a good credit record
• Standard home buyers might well be able to put down a fairly small deposit, but this isn’t the case with buy-to-let. The minimum deposit could well be in the region of 25% of the asking price – although the better deals might be had by putting up 40% - so it’s worth factoring this in when you’re saving up
• Depending on the lender, you’re likely to be needing to earn a certain amount to qualify for a buy-to-let mortgage. It’s fair to say that you’re not likely to be successful if you’re earning less than £25,000 a year
• Lenders won’t want you to be paying this off beyond a certain age – that means your buy-to-let mortgage probably needs to be paid up before you are 70/75
• The fees and interest rates you pay for these mortgages can be higher – brace yourself for this
• Most buy-to-let mortgages are ‘interest only’. This means you only pay the interest each month, with the rest of the loan paid off when you sell the home. That means the mortgage payments should be relatively low.
Tax relief: What is it and what do the changes mean?
It’s important to note that the rules around buy-to-let are changing. One way is in the tax relief that can be claimed by buy-to-let landlords. Previously, landlords were allowed to take the mortgage interest ‘off’ their profits when calculating the amount of tax they needed to pay (know as offsetting). However, these rules have been changed to reduce the amount of relief that can be claimed.
The best way to explain this is with an example.
So, let’s picture a situation in which you earn £10,000 per year from rental income and pay £5,000 in mortgage interest. Let’s also say that you also have costs and fees amounting to about £1,000.
Currently your profit is calculated as £4,000 (£10,000 minus the other two figures). You then pay tax on this figure. The amount you pay depends on your income tax band so basic rate payers would pay £800 (20%) while higher rate payers would pay £1,600 (40%).
Note, the income tax bands work as follows:
• you pay nothing on the first £11,000 you earn (this is known as the ‘personal allowance’)
• earnings between £11,001 and £43,000 come into the ‘basic rate’ band at 20%
• income between £43,001 to £150,000 is classed as ‘higher rate’ and taxed at 40%
• beyond this – above £150,000 - there is the ‘additional rate’, taxed at 45%.
It’s worth noting that some people might have a slightly different personal allowance and that these rules are open to change. It’s worth checking with the Government if you’re unsure about your income tax band.
However, when it comes to tax relief, new measures are being brought in gradually between now and 2020. These are on a sliding scale but, for ease, let’s look at what the picture will look like by 2020, when the changes will have been introduced in full.
Using the same figures and scenario from above, it would be determined that you had made a £9,000 profit. This is the £10,000 income, minus the £1,000 costs. You then pay tax on that profit and the interest is not offset. Instead, everyone – no matter what their tax band – will be able to claim a 20% deduction on the mortgage interest that they pay.
So, going back to that £9,000 profit, here’s what it means. A basic rate payer pays 20% tax on the profit, or £1,800. They can take off 20% of their £5,000 mortgage interest, which is £1,000. That means a tax payment of £800.
For a higher rate payer, there’s 40% of £9,000 to pay – so that’s £3,600. They then take off 20% of £5,000 – which is £1,000 – and are left with £2,600 tax to pay.
In this scenario, the basic rate payer actually pays the same tax as before. However, that doesn’t mean that there is no change as a result of the new rules. Remember, they are now classed as having a £9,000 profit and not £4,000. That all counts towards their income and could well impact upon which income tax bracket they fall into. Your income will be calculated by whoever files your tax return. If you’re unclear on how to do this you should speak to an accountant or you could contact HMRC.
The National Landlord’s Association reckons this could force an extra 440,000 people into a higher tax bracket so it isn’t an insignificant change, although this higher bracket is due to rise to cover those earning £50,000 by the time the changes come into effect. It’s well worth keeping a close eye on all future budget announcements from the Government in case these rules are altered any further.
Read the Government’s post on this for more information on the changes and a year-by-year breakdown of how they will take effect.
Yield: The number all landlords need to know
You’ll hear people talk a lot about the ‘yield’ to be had from property. This is a way of measuring the rental potential of a property and is the amount of rent that can be earned in a year, stated as a percentage of the price of the house.
So, if the £10,000 income stated in the example above came from a house costing £200,000 you’d say that the yield is 5%. It’s helpful to use a percentage because then you’re able to see the houses that, pound for pound, earn the most for you. For example, a £10,000 income on a £160,000 house would be a rental yield of 6.25%, showing you the greater value you are getting from this property compared to the previous example.
All sorts of factors can impact upon the yield and this certainly isn’t just a case of bigger or more expensive houses providing better returns. There can be a high yield where there is:
• a shortage of properties
• strong demand for a particular reason, such as a university nearby
• proximity to good schools
• a strong economy with good jobs
• new infrastructure – such as road or rail links
• a population of young people not yet ready to buy
This all means that the yield can be wildly different within a town or city. So, you might see lists – such as this from the Telegraph – saying that Sheffield is the best place for yield but it doesn’t necessarily mean that every property will get you a great yield.
How do you know what the yield will be? You can get a rough estimate from using sites such as Zoopla. Pop a postcode into the ‘house prices and values’ tab on the home page and you’ll get a rough estimate of the price and the potential rental income. This is only a rough idea. You can then use the calculator from This Is Money to calculate your yield.
Assured shorthold tenancy: What is it?
An ‘assured shorthold tenancy’ is the name given to the most common form of tenancy agreement (it’s sometimes referred to as an AST or shorthold tenancy).
This basically means that the tenant has a period – often six months or a year – in which their stay in the property is secured. Rent cannot be increased during that period. Beyond that you can either establish a new fixed term period or continue on a rolling basis.
This isn’t the only type of tenancy, but it is the most common. Others deal with renting rooms, lodger arrangements or renting to companies. Check out the Residential Landlords Association for more details.
Tenancy Deposit Protection: What you need to know
Your tenants will more than likely have to pay a deposit and there are rules about the way you need to look after this money for them.
You must use a tenancy deposit protection (TDP) scheme and, in England and Wales, you can pick one of three options for this (Scotland and Northern Ireland have their own separate schemes).
You can use:
• Deposit Protection Service (Custodial and Insured)
• Tenancy Deposit Scheme
The money must be paid into one of these schemes within 30 days and if you fail to do this you could face a big fine – which could be three times the initial deposit taken.
At the end of the tenancy, you have to reach an agreement over the amount of deposit that will be returned. If there is a dispute – if you believe the tenant owes money for repairs, say – then you can state your intention to deduct this from the money held in the scheme. If the tenant disagree you can contest this, for free, with the alternative dispute resolution (ADR) service or, at a cost, in court. At this point the portion of the deposit that is not contested by either party should be released and the rest kept in the account until a resolution is arrived at. If there’s no dispute, then this money is released from the scheme.
HMOs: What are these?
Like so many other sectors, the housing market loves a good acronym and HMO is one that you might come across.
It stands for ‘house in multiple occupation’ and, although you might hear it applied to all sorts of properties there is an official definition, set out by the Government.
It states that an HMO will have:
• at least three tenants in ‘more than one household’ and
• have a shared toilet, bathroom or kitchen
Homes are classed as a ‘large HMO’ if they are:
• at least three storey in height
• contain at least five tenants which are from more than one household*
• there is a shared toilet, bathroom or kitchen
*Relatives or married couples are classed one ‘household’ as per the definition. Examples of HMOs are student houses, bedsits or homes split up and rented out to single people.
Large HMOs need a licence from the local authority – and failure to do this could result in a fine amounting to 12 months’ rent.
You can read more about HMOs in our post on the topic.
Stamp Duty: How does this work?
Stamp duty – or stamp duty land tax – is an upfront cost that anyone buying a house must pay to the Government.
The rules on this tax have changed recently, meaning that buy-to-let investors now have to pay 3% more than someone who would be buying a property to live in it.
The rate of stamp duty you’ll have to pay depends on the purchase price, with levels as follows:
Below £125,000: 3%
£925,001-£1.5 million: 13%
£1.5 million-plus: 15%
It’s worth noting the way this is calculated as it’s not as straightforward as saying that a house priced £275,000 will need 8% stamp duty – you pay tax on the ‘portion’ of the price that falls into each of those brackets.
The best way is to look at an example. Here’s one from the people at Which?:
So, if the price is £275,000 you will pay £12,000.
This is calculated as follows:
*3% of the first £125,000 of the price (£3,750)
*plus 5% on the next portion up to £250,000 (£6,250)
*plus £8% of the last portion (£2,000)
You can use the Government’s Stamp Duty calculator to help work out the bill for your property.
Capital Gains Tax on property
Capital Gains Tax is the tax that you have to pay on the profit you make when you sell an asset, in this case the house you’ve bought as a landlord. It’s important to note that you pay tax on the amount this has gained in value, not the amount you sell it for.
You need to be aware that the Capital Gains Tax paid on property is different from other types of assets. The tax is charged at 28% for higher rate payers, or 18% for basic rate payers (if they’re within a basic income tax band).
The Government’s guide to this should fill you in on the details surrounding exemptions and payments when it comes to Capital Gains Tax.
Limited company loophole: Is this an option?
You might well have heard about a way in which some people are trying to mitigate the potential losses caused by changes to rules over buy-to-let tax relief. This is sometimes known as the ‘limited company loophole’.
In essence, this involves landlords setting up a company and then ‘selling’ their homes to these companies. That way, tax relief can be gained by counting the running costs of a buy-to-let as an ‘allowable expense’.
There’s a debate over whether or not this ‘loophole’ actually works. As a company you do have to pay 20% Corporation Tax on the taxable profits you make (although this will drop to 18% by 2020).
Changing the ownership of a property might cause a fee or early repayment charges and there will be plenty of paperwork.
The only way to determine the best route for you is to sit down with an accountant and cost everything out.
Selective licensing is a power open to local authorities where there is a specific problem – such as low demand or an issue with anti-social behaviour – in a bid to involve landlords in the solution.
In these areas, landlords have to obtain a licence and failure to do so can result in a big fine.
There is much debate on the need for selective licensing – with property expert Carl Agar describing this as using a ‘sledgehammer to crack a nut’ used by councils to tackle anti-social behaviour or low demand. He feels it is not something to be feared by landlords who manage their properties properly and comply with the rules.
Read our guide on this for more information.
Finally, there’s landlord insurance. This is where we come in. It’s important to note that standard home and contents insurance is not sufficient to cover you when you have a buy-to-let property.
Take a look at our cover and see what we can do to protect you if the worst were to happen and then fill in a few details to get a quote from us.
The Immigration Act and the right to rent: Responsibilities for landlords
The Immigration Act came into force in 2016 and aims to make it harder for illegal immigrants to work, live and access services in the UK. Landlords need to be aware of this because part of the act involves asking them to check a tenant actually has the ‘right to rent’ in the UK.
The 2016 act actually strengthened the rules on the right to rent after a trial of the principle in the West Midlands and you may well have read about this law while it was being drawn up and debated.
It’s worth noting that landlords have to perform these right to rent checks on all new tenants – not just those that they think look to be from outside the UK. The checks cover anyone aged 18 and over, even if they’re not named in the tenancy agreement or, indeed, if there isn’t a tenancy agreement.
Someone is deemed to have the right to rent if they are either British, Swiss or from the European Economic Area (Austria, Belgium, Bulgaria, Croatia, Republic of Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, Netherlands, Norway, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden and the UK). People from outside of those countries might have been granted the right to enter or remain in the UK – either for a limited or indefinite period.
To conduct a right to rent check you need to:
• Ask a tenant for original documents that prove they have the right to be in the country
• Check that these documents prove they have the right to rent in the UK
• Make and keep copies of the documents and make a note of the date you made the check
Failure to comply with these is now, as of December 1 2016, a criminal offence that could be punished with an unlimited fine (previously this was £3,000 per tenant) and even up to five years in prison. It’s worth stressing that this is easily avoided by carrying out these short checks and that there is help at hand to help you carry them out. The rules aren’t there to catch people out, they’re there to target the people who abuse the system.
The Government has produced a handy guide of the sort of documents that you might be given and advice on how to check them and it’s well worth having a read of this.
The Government offers a checking service online and has produced a guide on the right to rent if you want to read more about this.
You can also call the landlord’s helpline on 0300 069 9799. This is open Monday to Thursday, 9am to 4:45pm or on a Friday from 9am to 4:30pm.
Tenant referencing: Choose the right person to rent your property
As a landlord, you will want to have confidence that the tenant living in your property is going to look after it. They are the people you are relying on to look after your investment on a day to day basis, after all.
That’s where tenant referencing comes in. By paying for a reference for your tenant you are able to establish a number of pieces of information that give you an insight into their financial status and background and help you to make a letting decision with peace of mind and full possession of the facts.
Tenant referencing can allow you to determine a number of things, including:
• Any adverse credit history
• Confirmation that bank details are correct
• Old names and addresses that haven’t been disclosed to you
• Information on whether the tenant has been unable to pay rent in the past
• Details from their employer about their job stats
• Checks with former landlords
Our packages range from £18, read more to see which will be best for your needs.
Landlords legal liability: Covering you in case of accidents
If a tenant or a visitor were to have an accident in your property then there is a chance they might make a compensation claim against you as the landlord. A loose floor tile or stair carpet could, therefore, prompt a legal battle to establish whether or not you should be held accountable.
Landlords legal liability – or property owner’s liability insurance – is the cover that allows you to rest assured that you can get support in such a scenario. It’s basically like the public liability insurance businesses need but for you and your property. It can pay damages and/or legal fees.
According to the Association of Residential Letting Agents (ARLA), personal injury claims have increased by 85% since 1990 and awards over £100,000 are not uncommon, so it’s easy to see the value of having this cover.
Simple Landlords cover can cover you for £2 million as standard, with the option to upgrade to £5 million.
Taking your property back: Understanding Section 21 and Section 8
Section 21 and Section 8 are parts of the Housing Act 1988 that allow a landlord to take back possession of their property.
This is relevant for private landlords who are letting their property on an assured shorthold tenancy (see above).
The main difference is that Section 21 refers to getting back a property once the fixed term of the tenancy has ended and Section 8 refers to getting it back during the tenancy period.
Section 8 notices have to be issued using a special form - Form 3: Notice seeking possession of a property let on an assured tenancy or an assured agricultural occupancy – and require a notice period of anything from two weeks to two months, depending on the reason for you to take your action.
Reasons to issue a notice can include:
• Rent arrears (eight weeks if paid weekly, two months if monthly, one quarter is annually)
• The house being repossessed by the mortgage lender
• The tenancy agreement being breached
• Damage to the property from neglect
• A conviction due to illegal activities in the property
• If false information was given during the application.
If the tenant refuses to leave on the date specified in a section 8 notice then you will need to apply for a possession order. If they still won’t go, you need to apply for a warrant of possession from the court and arrange for a bailiff to evict them.
Section 21 notices need at least two months’ notice in writing. They can be issued before the end of the fixed term of a tenancy, but only if the two month notice period will mean that the tenant leaves after this fixed term ends.
If the tenancy was created after 1 October 2015 you have to use Form 6a: Notice seeking possession of a property let on an assured shorthold tenancy. If not, you will just need to give two months’ notice in writing.
If the tenant does not go on the date that you request in your section 21 notice then you need to apply for a possession order from the courts. However, unlike with a section 8 notice, you might be able to speed things up and avoid going through the courts by using the Claim for possession of property (accelerated possession procedure) (N5B) form. The Government also offers this as an online service.
Subletting: What landlords need to know
Subletting is the name given to the practice of your tenant renting out part of a property themselves to another person. This is not illegal but, in most cases, the tenant should ask their landlord for permission.
This has become an issue in recent years, especially since the advent of people renting out rooms on websites such as Airbnb. Indeed, the National Landlords Association estimates that nearly half of tenants who sublet do so without their permission.
The Government had said that it wanted to make it easier for tenants to sublet as part of plans to boost the ‘sharing economy’ but, as yet, those plans are yet to materialise.
Tenants should only sublet part of the property as if they were to rent out the whole property they would lose their status as tenant and could face eviction.
If a landlord permits a tenant to sublet out a spare room then they should take time to stress any rules and responsibilities and ought to check that it does not compromise their insurance policy.
How the Deregulation Act impacts on landlords
The Deregulation Act came into force in 2015 and attempted to tidy up lots of laws that were either confusing or no longer necessary.
There were three key things that came out of this for landlords to be aware of.
Energy Performance Certificates: It was made clear that a landlord would not be able to take back possession of their property using a section 21 notice if an energy performance certificate and gas safety certificate had not been issued.
Tenancy Deposit Protection: The rules around how deposits are kept on behalf of tenants were clarified. The changes were complicated but you should find the rules are clearer. The Government’s page on this explains the rules as things stand and it’s best to focus on this.
Section 21 notices: Landlords will not be able to serve a Section 21 notice during the first four months of the originating tenancy. Also, the notice will only last for six months and expire after that period. Also, if a tenant serves a written complaint on a landlord, the landlord must respond within 14 days and explain what action they will take. If this does not happen and the tenant complains to the council the local authority could issue an improvement notice or carry out emergency action themselves. If all this occurs a landlord will not be able to serve a Section 21 notice until the work is signed off by the council.
Fire alarm enforcement: What do landlords need to do?
The Smoke and Carbon Monoxide Alarm (England) Regulations 2015 state that landlords need to install and check smoke and carbon monoxide alarms in their properties.
The rules state that:
• Landlords need to provide a smoke alarm for each floor of their property and…
• …a carbon monoxide alarm in any room which is mainly used as for living accommodation and contains heating described as a ‘solid fuel burning combustion appliance’
There are separate rules on this for Houses in Multiple Occupation (HMOs).
If a local authority believes that the rules have been breached then they can issue a landlord a notice asking them to take action within 28 days. If the landlord does not respond, the council could get permission from the tenant to go in and install the alarm and issue a fine.
If you have any questions you can read the Government’s Q & A booklet on this topic.
Wear and Tear Allowance replaced with a new form of relief
Landlords can claim tax relief for the money they need to spend on ‘wear and tear’ for their properties but the rules surrounding this have recently changed.
Previously this amounted to being able to claim 10% of the gross rent regardless of the physical cost of providing or replacing items. That system has now been replaced and the new rules give relief for the cost of replacing items as and when this actually occurs.
This means the cost of things such as furnishings, appliances and kitchen units etc.
The Government states that: “The relief given will be for the cost of a like-for-like, or nearest modern equivalent, replacement asset, plus any costs incurred in disposing of, or less any proceeds received for, the asset being replaced.”
This just means that it is important for landlords to keep a record of anything they spend on their properties and have it to hand when it comes to calculating tax either as individuals or with the support of an accountant.
What did the Housing and Planning Act change?
The Housing and Planning Bill attracted a lot of attention in the rental sector and became law, and therefore an act, in 2016.
With any new legislation from the Government it’s important to take a little time to look at what it will mean for you as a landlord.
The relevant changes in the Housing and Planning Act include:
• a rule that makes it possible to take back an abandoned property without needing to issue a Section 21 notice or court order
• an expectation that letting agents will have to sign up to the SAFEagent Scheme which, in essence, protects your rent money while it being held by the letting agent. This should help to cover you if a letting agent were to go bust, for example
• tougher rules to create a database of rogue landlords and ban some people from letting property. Legitimate landlords should welcome steeps to root out these operators, who can give a false reputation to the sector
• new rules over when a local authority can issue a rent repayment order – this is largely when a landlord has ignored an improvement order, gained ‘violent entry’ to a property or falsely kicked someone out of a property
There were many other changes contained in the Act which you might have heard about. Some of these refer to the rules for council tenants – with fixed term tenancies, an extension of ‘right to buy’ to include housing association homes and increased rent for some tenants as part of ‘pay to stay’. These were all high profile and ‘right to buy’ and ‘pay to stay’ have been contested and the result of ‘u-turns’ by the Government. Such issues might attract attention but should not have a direct impact on private landlords.
Other measures include the building of more starter homes and the speeding up of the planning system.
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