Guide to buy-to-let mortgages for contractors
Table of Contents
Introduction
Are you a contractor eyeing buy-to-let? You can’t become a landlord overnight. But if you take advice, plan well and keep planning well, the rewards can be significant.
Aimed at flexible workers, this 7-part buy-to-let mortgage guide is designed to help you succeed as a landlord, by explaining:
- Is buy-to-let a good investment?
- What is a buy-to-let mortgage?
- How does a buy-to-let mortgage work?
- How much will lenders lend me to purchase a rental property (‘SICR’)?
- Should my limited company own the rental property; what sort of property and where?
- HMRC issues like CGT, allowable expenses, and Stamp Duty Land Tax (SDLT)
- Landlord responsibilities, considerations, guidance and tips
Buy-to-let landlord tax measures
- Since Oct 31st 2024, an additional 3% Stamp Duty levy introduced in 2016 was increased to 5% on all buy-to-let property purchases
- Since 2017, mortgage interest relief has been subject to restrictions (under Section 24 of the 2015 Finance Act)
The return on investment of rental property has reduced due to these HMRC changes.
A mortgage broker who specialises in both contractors and buy-to-let can assist you with these tax changes.
Freelancer Financials top tip
The best broker will secure the right, safest and most tax-efficient mortgage you can possibly get.
To ensure affordability, the broker may recommend a limited company to buy your envisioned rental property, as limited companies are still exempt from 2017 mortgage interest relief restrictions.
1. Is buy-to-let still a good investment?
The HMRC changes have not stopped many contractors from continuing to use investment properties as their ‘Plan Bs.’
Attracted by its “safe as houses” reputation, limited and umbrella company workers tend to start a buy-to-let investment and then build on it, as they often prefer it to the ‘guessing game’ of stocks and shares.
Our take? The market for landlords will always exist as long as a shortage of affordable property exists. And house prices have risen almost continually since the financial crisis of 2008.
Inflation, interest rates and geopolitical factors aren’t to be underestimated, however.
Freelancer Financials top tip
Obtain tailored advice about achieving then safeguarding your profitability, before taking even your first financial decision as a budding landlord.
2. What is a buy-to-let mortgage?
Lenders won’t let you use a standard residential mortgage to purchase a property to rent out to tenants.
Instead, a buy-to-let mortgage is required and typically, it’s an interest-only product.
In this context, ‘interest-only’ means the interest rate on the mortgage is payable with the tenants’ rental income. Subtract those two figures, and that’s your profit.
You may have only one tenant. And that’s fine because lenders do separate their buy-to-let products into three — for accidental landlords; for first-time investors, and for large or serial property investors.
3. How do buy-to-let mortgages work?
Aside from profit, or ‘rental yield (the monthly or annual return achieved as a percentage of the property’s value), investors and landlords also like to know from us how much a lender will offer.
Remember, as this isn’t a residential mortgage (where personal income is assessed), a buy-to-let mortgage’s key affordability criteria is the potential rental income of the property.
While the lender’s figures can sometimes raise eyebrows, a good broker can steer you in the right direction. A broker’s close relationship with a lender, even the traditional ones, can be key here too.
However, you should be aware that the mortgage product’s interest rate and deposit requirements, which can be higher on buy-to-let, are usually at the lender’s discretion.
Applying for a buy-to-let mortgage
A rental affordability calculation — also known as a stress test– run by your mortgage provider will decide your borrowing power.
As mentioned, the property’s potential rental income dominates how much you can borrow.
However, if the income is very low, the personal income of the borrower could be taken into account.
Known as ‘Top Slicing,’ this method is not always accepted by lenders.
Therefore, choose a broker who both understands contractor income and has good relationships with those lenders that will top slice.
Do lenders expect different things from basic and higher-rate taxpayers?
Relating further to personal circumstances, lenders differentiate between borrowers who HMRC categorise as ‘Basic rate’ (1), and ‘Higher rate’ (2).
In percentage terms, per month, this means:
- The rental income must be 125% or more of the interest payment
- The rental income must equate to upwards of 145% of the interest payment
Tread carefully here, there is more to lender stress tests than just the above!
For example, affordability for basic rate taxpayers (earnings between £12,571 and £50,270 in 2025-26 ), will be based on a nominal rate of up to six per cent.
Freelancer Financials top tip
To accurately calculate your chances of jumping through a lender’s hoops, consult a broker who can negotiate closely with a lender’s most senior staff.
4. Stress Test Calculations: how lenders assess mortgage affordability
Let’s look at how lenders use the stress test to see if you can afford a buy-to-let mortgage.
Taking the rental cover rate (between 125% and 145%), lenders then use a Stress Interest Cover Ratio of up to 6%.
To reassure you, the ‘SICR’ is typically 5.5%, but things seem to be getting more expensive nowadays, so we’ve added a bit on just to prepare you for the unexpected!
SICR details: Your buy-to-let mortgage
- Mortgage loan: £400,00
- Nominal stress rate: 6%
- Rental cover (basic rate taxpayer): 125%
How much annual interest?
Annual interest = loan amount (£400,000) × stress rate (6%) = £24,000
How much minimum annual rental income?
Minimal annual rental income = Annual interest (£24,000) × rental cover (125%) = £30,000
So, the minimum monthly rental income = £30,000/12 = £2,500.
Freelancer Financials top tip
If you’re still not sure, crunch some numbers using the buy-to-let rental income calculator here.
Is failing a lender’s stress test the end of my buy-to-let dream?
Top Slicing comes into its own where lenders decide your rental income won’t stack up against your monthly repayments.
In our experience, which includes working closely with lenders who do top slice, there are three options to explore if you don’t pass the stress test calculation:
- Increase the duration (“term”) on the fixed-rate
- Consider adding more money to the deposit; and thirdly
- Convince the lender to be more flexible by highlighting your property portfolio (if applicable).
How much deposit on a buy-to-let mortgage?
The fastest way to estimate the deposit is to use our online buy-to-let mortgage calculator.
Only a broker can advise you, precisely, on the very latest deposit stance of your preferred lender.
As a ballpark though, 20% is the least you’ll need to put down and 40% is the most. And that’s almost regardless of your flexible worker status, whether you’re a locum, an agency worker or on a zero-hours contract.
Freelancer Financials top tip
Putting down a deposit of 40% — almost half the property’s value — is how to unlock the very best deals.
5. How to buy the best buy-to-let property: six must-ask questions
Agents in the catchment area you’re eyeing are your ‘go-to’ for choosing the right investment property.
Answer these six questions yourself though (before telephoning an agent), to avoid being talked into something you don’t want:
- What type of tenants are you seeking?
- What type of rental property is best for you; a flat, a house, or something even bigger like a HMO (House in Multiple Occupation)?
- Will you buy in an area you know — nearby, or go further afield to get better value for money?
- What’s your investment strategy, and will it hinge on monthly income, and/or capital appreciation?
- Will you use an agent to manage the property, or will you cut costs by managing it yourself?
- Will you use a limited company to buy the investment property?
Popular among contractors, this latter option is known as using a Special Purpose Vehicle. And it’s explained later in this guide.
With your answers to the above six jotted down, ring a trusted estate agent in your chosen vicinity to start viewings!
Freelancer Financials top tip
Let the agent share their nuggets of wisdom about the rental market, including any ‘hot’ areas where your yield would be optimal.
Is a lettings agent worth it?
A lettings agent could cost up to 15% of your bricks and mortar’s rental income!
But you get a lot of admin, management and property maintenance in return from the agent, ranging from them sourcing tenants and collecting the rent to even running legally-required checks on your behalf.
6. How HMRC taxes buy-to-let landlords
As well as the 5% surcharge (since Oct 31st 2024) on top of residential SDLT rates you’ll suffer, HMRC will also levy income tax on your rental income.
While income tax is charged under your standard income tax banding, it’s a declaration that all landlords need to make as part of self-assessing with HMRC. You’ll do this on form SA100.
Positively, how much you’ll owe in income tax (for your SDLT liability use our calculator here) can be mitigated by deducting up to 10 ‘allowable expenses’ that HMRC lists on its website.
Expenses are allowable as a landlord if they are incurred “wholly and exclusively for the purposes of renting out the property.”
So allowable expenses include general maintenance, repairs, council tax and insurance, as well as letting agent fees, water rates, utility bills and, if you’re a basic rate taxpayer, tax relief on the interest of the buy-to-let loan too.
Freelancer Financials top tip
Hire a qualified accountant to manage and process your allowable expenses as a landlord. And yes, accountant fees qualify as an allowable expense too!
Do buy-to-let properties attract CGT and IHT?
We also recommend hiring an accountant because CGT will be payable to HMRC when your buy-to-let property is sold, although CGT is only paid on its increase in value.
Furthermore, be aware that inheritance tax is payable on all buy-to-let properties. So investment properties don’t have immunity from IHT, and they would form part of your estate.
The limited company structure is an additional reason to have an accountant advise you on the tax side of your buy-to-let strategy.
7. Use a limited company to buy investment property: overview
Rather than owning the rental property as an individual, you become the company’s director and in that role you take out the mortgage.
Reductions to both interest tax relief and ‘wear and tear’ allowance have made company-owned buy-to-lets popular in recent years.
Yet a limited company (or Special Purpose Vehicle) mortgage isn’t ideal for everyone.
It depends on your investment goals and financial resources, as interest rates are higher than for non-corporate landlords.
Freelancer Financials top tip: Contractors who have previously worked through a limited company must appreciate a ‘LTD’ for buy-to-let is a different animal. Both an accountant and mortgage broker should be consulted prior to using a SPV, even if this structure offers more tax planning opportunities.
Be aware, landlords have NUMEROUS responsibilities…
Some responsibilities aren’t a legal requirement (buy-to-let insurance) but some are (keeping the rental property safe and free from hazards, which means fitting smoke alarms, carbon monoxide detectors, and equipment safely).
Some responsibilities relate to tenants, such as providing them with a ‘How to Rent’ checklist and EPC. You must also keep up-to-date with regulations, as EPCs have been required since 2008 but category ‘C’ will be compulsory from 2030.
Freelancer Financials top tip
Supplement speaking to a broker with your own research, due diligence and responsibilities checklist, so you are always across your legal responsibilities as a landlord.
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