Budgeting for a buy-to-let mortgage
In previous buy-to-ley mortgage guides we reviewed the additional commitments that you are legally bound to as a landlord and reviewed the basics of buy-to-let mortgages.
In this mortgage guide, 'Budgeting for a buy-to-let mortgage', we look at the financial considerations that can impact you as a landlord. The financial costs and fees discussed in this mortgage guide can be calculated online in our Buy-to-let Running Costs Calculator which compliments this guide to support you with your financial planning and budget. If you are currently looking to purchase a new property you may find our Cost of moving home calculator (Advanced) useful, this contains elements which may not be relevant to you as a landlord (moving costs etc.) but the key factors such as stamp duty, mortgage fees, solicitors fees etc. are encompassed and remain a valid expense. The tool will also allow you to calculate the associated costs of selling a property, a useful benchmark if you are selling one property to buy another.
Creating a solid budget for your buy-to-let property (ies)
Purchasing costs are the financial outgoing you will need to cover when proceeding with a buy-to-let mortgage. Purchasing costs are typically one off, that is once paid you can remove them from your budget. If you have a purchasing cost that is going to be an ongoing cost, a lease for example, we suggest you budget this as a running cost.
The table below covers the purchasing costs that you will encounter as a landlord. We assume that you are familiar with these, if not, you can read about each element in detail in our Mortgage Fees Guide, you can also use our Mortgage Fees Calculator which supports the mortgage fees guide and allows you to calculate how much you should set aside when budgeting for your mortgage.
But-to-let Budget Plan
|Fee||Who gets it?||What is it for?|
|Arrangement fee||Mortgage Lender||Arranging the mortgage|
|Booking fee||Mortgage Lender||Mortgage application process|
|Valuation fee||Mortgage Lender||Property valuation|
|Survey fee||Mortgage Lender||Property condition check for mortgage validity|
|Broker fee||Mortgage Broker||Brokers work and associated activity on your behalf|
|Stamp duty||Government||War in France|
|Conveyancing fee||Solicitors||Legal and property check|
|Land Registry fee||Land Registry (via a solicitor)||Records you as the owner of the property|
|Chaps fee||Mortgage Lender||Electronic transfer of mortgage funds|
|Completion fee||Mortgage Lender (via a solicitor)||Covers cost of transferring the mortgage funds or /and releasing the mortgage deeds|
|Early Repayment Fee||Mortgage Lender||exiting mortgage ahead of agreed contract date|
When you take a buy-to-let mortgage and charge tenants rent for your property you become a landlord. Being a landlord is effectively the same as running a small business in that you need to start budgeting for your income and expenditure on a monthly basis.
A business would refer to the periodic expenses as operational costs, that wording can seem a little heavy, particularly if you are a new landlord so we will stick with running costs.
The best financial approach to budgeting for running costs is to have a flat monthly plan. Monthly budgets are most effective as it ties in with rental income making it easy to see the balance of income and expenditure.
Calculating the income from your property or properties is very straightforward, budgeting for finances can be a little trickier. Some expenses will be annual, quarterly etc. We strongly suggest that you split these into equal monthly expenses and budget for them accordingly. It is good practice to retain any budgeted income for expenses in a separate account, a savings account for example. This makes it very easy to clear any bills as and when they come in. This in turn will ensure you maintain a good credit score and avoid any unnecessary stress.
As with all financial planning, the best plans include planned and unplanned events. Unplanned events are, surprisingly, those financial events that you either aren't aware of or thought would never happen to you. A tenant putting a 1000 gallon fish tank in a loft extension for example, that full tank being broken by a bowling ball. All far fetch, right? wrong, these things happen, do not assume that your tenants are perfect, everyone has accidents and, if theirs affects the property it may well end up being you who picks up the bill. In fairness most tenants are fine, you won't have any issues but you should always plan for the worst, hope for the best.
As a landlord you are not entitled to the typical consumer rights protection that comes with traditional investments so it is essential that you budget correctly, when you become a landlord you are pretty much on your own and responsible for your own success or failure.
We will start by looking at the elements which can be considered as planned financial expenditure.
Planned Financial Expenditure
- Buildings insurance: Buildings insurance is compulsory as part of the by-to-ley mortgage contract, do not be tempted to overlook buildings insurance.
- Landlord insurance: Landlord insurance isn't a legal requirement or a condition of the buy-to-let mortgage but it can help protect you and your investment if things go wrong.
- Monthly Mortgage Repayments: Monthly mortgage repayments on buy-to-let mortgages must be paid every month, on time, regardless of whether you have tenants in the property or not.
- Mortgage Interest: As a landlord you can offset the interest you pay on your mortgage repayments against your tax bill. The amount that you can offset is in flux with tax relief on mortgage interest payments due to phase out by April 2020, you can calculate your tax relief on mortgage payment for current and future years here.
- Maintenance Fees: If you choose to have an estate agent or property management company manage your property on your behalf. If you do choose this option ensure you check their competency, remember, they are your face when dealing with the tenant but, if things go wrong, you are still legally liable. Having a management property does not dissolve you of your legal responsibilities.
- Council tax: When your property is empty you become liable for any council tax due.
- Utility bills When your property is empty you are responsible for paying for any utility bills that are due. This includes electricity used whilst you or an estate agents show potential tenants around the property and utility bills for drainage water etc.
Unplanned Financial Expenditure
- Floods: The damage caused by water is often underrate until the experience happens to you. Depending on the severity, flood damage can range from something as minor as replacing carpets to structural repair or full property rebuild... something that not many can afford to cover.
- Fire: Did you know that since 2010 the number of properties caused by fire damage has doubled in some UK counties? This is thought to be a consequence of reduce fire service coverage and increased response times borne of austerity measures. Some point out the increased use of electrical appliances in the home, particularly smaller electrical devices (phones, tablets etc.) which are often left plugged in charging overnight. This is a key consideration for landlords, if your property doesn't have sufficient electrical sockets, install more! Forcing tenants to use extension leans is not a good solution and for the sake of a couple of hundred pounds makes no sense. It is not just your investment you are gambling with, it is their life(s).
- Wind: Damage by wind can include dislodged slates (leading to water damage), chimneys being blown over, trees being blown over (leading to impact damage) and so on.
- Earthquakes: We tend to be fortunate in the UK when it comes to earthquakes but they do happen. We mention as a more common event is a sinkhole (which we mention below), sinkholes tend to be classified as earthquakes for insurance purposes so check the policy for interpretation before you commit to the policy.
- Tenant Damage: Even the best of tenants can cause damage accidentally. In some circumstances the tenant may be liable for the damage AND pay for it, in others they may not be liable or simply refuse to pay. Either way, the best practice is to set a portion of your income from rental properties aside, if you don't spend it, all the better, the funds can always be sued for other investments/opportunities.
- Subsidence: The Association of British Insurers suggest that there has been a 50 per cent increase in the number of subsidence claims since 2002 taking UK insurance claims for subsistence to over 40,000 claims per year. Subsistence occurs when the ground or footing beneath the property move, typically downwards, resulting in the distribution of weight on the property becoming unstable and the support for specific part of the property becoming compromised. The obvious sign of subsistence is horizontal cracks/gaps in the mortar between the brick work on properties though this can just be normal settling when seen in some older buildings.
- Mould: Mould comes in many forms (there are over 1000 different types of mould) but usually forms when there is the right combination of warm air and moisture. Note that warm air can be caused by decomposition, so if something is rotting in your property, it will normally cause mould. Mould can cause serious health issues, as a Landlord you have a legal duty of care and failing to deal with either the mould or the issue that causes the mould to form can have serious effects. It is not unheard of for tenants to take their landlords to court for health issues resulting from mould which was reported but never addressed by the landlord.
- Drains and Sewers: Depending on the age and condition of your property, it is feasible that your drains and sewers that they feed into are in excess of 100 years old. Over time, movement occurs, particularly with changes to wiring and street repairs (vibration / impact damage). This in turn can lead to leaks or blockages which result in the waste water returning back into the property. If any liquids flow back into your property which have been contaminated with sewage, even a small amount, then you will be looking at significant cost. When water is contaminated with sewage. Any goods which come into contact with sewage contaminated water will typically need to be destroyed and replaced. This will include all fixtures and fittings and, depending on the severity, mean all floorboards, plaster and medium which has absorbed the contaminants. there is no hard and fast rule but as a general guideline, if it can be fully disinfected and confirmed free of contaminants then the goods may be reused, confirming something free of contaminants however is difficult and, should your tenant become ill due to the after effects of living in a property which remains contaminated it is you, the landlord, who could face serious legal action.
- Terrorism: For most landlords this is an unlikely event but we raise as food for thought. Buildings damage cause by acts of terrorism is not always included in general buildings insurance policies
- Sinkholes: Some may scoff at the thought of a sinkhole causing damage but the number of sinkholes reported annually is on the increase. This is thought to be due to the increased intensity of rain water combined with the natural settling of earth, whether due to dissolving minerals (limestone etc.) or backfilling voids created by man-made activity. Whatever the cause, the impact is real. A sinkhole will typically be seen akin to an earthquake or natural ground movement and is unlikely to be covered under a general buildings insurance policy.
Unplanned expenditures are of course difficult to second guess and their financial impact can be devastating. This is why it is very important that you take out a good buildings insurance, you should also thoroughly check through what is covered.
Buildings Insurance: Are you covered?
Buildings insurance is your safety net, for most private landlords it is the single point fo failure that can make the difference between financial success and financial ruin. Sadly many landlords have been caught out, not by avoiding buildings insurance as you may initially think but by taking out buildings insurance policies on their properties without fully reviewing and understand exactly what cover is provided.
The past few years has seen an increase in property damage due to extreme weather conditions and many landlords found themselves coming unstuck as they discovered the policies they had taken provided only partial cover or no cover at all. How does this happen? Inappropriate insurance policies or bad cover are normally the result of poor attention to detail, it is far too easy to assume everything is fine, it's all covered and focus on the cost of the insurance rather than what it actually covers.
Far too many landlords learn that their buildings insurance isn't sufficient the hard way. Common sources of unexpected property damage which may require additional policies are:
- Natural Disasters (Flood, Wind, Fire (certain types) and Earthquakes (+sinkholes)
In this mortgage guide we have looked at the costs you will encounter when buying a property to let out and the ongoing running costs. We have underlined that, although a good budget helps you survive the unexpected financial costs that, surviving the big challenges is likely going to need the right type of buildings insurance. More importantly, the building insurance has to encompass the risks that you want to cover so you must know and understand what you are paying for, learning after the event is not the right approach. What we want you to do is ALWAYS READ THE SMALL PRINT - IT IS UP TO YOU TO ENSURE YOU ARE COVERED!!! We hope this mortgage guide underpinned the importance of that as the best financial plan is what that covers you when something happens that you had never actually even thought of or considered possible.
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