Buy to Let Contractor Mortgages

Buy-to-let properties remain a popular form of retirement planning investment for UK contractors. Many contractors look to buy-to-let investments for two main purposes:

1. as a means to generate an additional source of rental income now;
2. to supplement their retirement planning from the capital appreciation of the property.

This remains true, despite the government raising taxes via both mortgage interest relief and Stamp Duty surcharges.

How secure an investment is buy-to-let for contractors?

The short answer is: very. Rental income aside, capital appreciation continues to perform over time.

Recoveries post-2008 financial crisis and COVID have seen property prices rise almost continually. And, despite ‘experts’ foretelling market collapses in both instances, they've not happened.

Even after recent tax upheavals, there’s still mileage in the adage, “safe as houses”. So, if you’re interested in investing and would prefer to put your money into bricks and mortar rather than stocks and shares, buy-to-let can outperform contributory pension plans.

They're also useful if a contractor has reached their lifetime allowance and needs alternative investment sources. It's as close to 'money for nothing' as most of us will ever get, just so long as you put the right foundations in place.

Advantages of using buy-to-let to generate a return:

Property investment generates rental income only if you get the right. There are hotspots up north with, rental yields reaching up to 9%. Down south, the capitol has seen rent inflation touching 10% in 2024.

 Capital growth can provide one of the best ways to make a sizeable return on investment. This is the main reason so many contractors mortgage second (or more) properties year after year. Capital growth rates in the property market are predicted to be as high as 20% by 2028.

There’ll always be a market for landlords so long as there’s a shortage of affordable properties and social housing. And, despite Labour's lofty promise of 1.5m homes during this parliament, experts are already calling it 'impossible'.

There are inherent risks to consider

You can mitigate some of the risks of becoming a landlord. You can insure against:

• loss of rental income,
• property damage
• and legal costs.

But you have to be aware that property investment isn't risk-free. Both domestic and global economic climates are far from stable. There are several potential threats affecting money markets, so landlords must be aware of inflation and interest rates. 

No matter how you get on with a mortgage lender or broker, you must speak to an independent financial advisor. They can point out the state of your finances and how prepared you are to become a property investor. 

Once you've done that groundwork, then start to look for a buy-to-let mortgage that helps you stick within budget. That's where a broker like us comes in.

How do buy-to-let mortgages work?

Buy-to-let mortgages work differently from residential mortgages. That's because they're predominantly a business tool. 

They work on a minimum yield (explained further on in this guide). The yield is the profit the landlord makes between what he charges his tenants and what he has to repay the lender.

Your situation will dictate which type of buy-to-let mortgage you need. On the market today, you'll typically find buy-to-let mortgages for:

• first-time landlords;
• ‘accidental’ landlords;
• professional investors with large property portfolios.

Most buy-to-let mortgages are interest-only, meaning the landlord uses their tenant's rent to pay the monthly interest on their mortgage. As the name of the mortgage implies, the landlord only pays interest on the home loan, and none of the capital.

Because it's a business tool, buy-to-let lending criteria differ from residential criteria. A lender will base buy-to-let affordability on a property's potential income, or its yield. In contrast, mortgage lenders assess residential affordability on the buyer's personal income.

While that may seem like a shoo-in, there is a key difference. Interest rates, Stamp Duty and the initial deposit are often notably higher with buy-to-let than with residential mortgage deposits, rates and taxes.

Buy-to-let mortgages for limited companies

With the recent reductions in tax relief and higher Stamp Duty, many landlords have set up a limited company to facilitate their property investment(s). Rather than repay the mortgage personally, the transactions go through the limited company, or SPV (Special Purpose Vehicle).

You'll really have to get into the nitty-gritty to see if this way of investing works for you.

Other things to consider

While you've got your broker, there are other things to discuss, most of which they'll (probably) bring up themselves:

• What is the goal for your investment property? Do you want to top up your monthly earnings, make a killing on the property in the long run, or a bit of both?
• Will this be a one-off investment, or are you looking to build a portfolio over time?
• What are your target tenants/locations?
  • (we cover this in further detail, below)
• Are you going to hire a letting agent or take care of running the 'business' yourself?

While you may not have considered these points yet, your mortgage broker will help you shape your long-term investment strategy. To succeed in this business, you must have a manageable project from the outset.

Getting a buy-to-let mortgage

As mentioned, a lender will base much of a landlord's affordability on the potential yield. But that's not the whole story.

If their rental affordability calculations return too low a rental income, some lenders will look to see what they can utilise of your personal income. This is called top-slicing. And, while it implies that you'll not get so much back from your investment compared to going solely with the rental income, it can work.

These calculations form what we call the “Stress Test” or “Stress Income Cover Ratio” (SICR). The actual figures lenders use differ from one lender to the next, and can be affected by your tax status (higher- or lower-rate tax-payer). 

Higher-rate versus lower-rate taxpayer income expectation differences

The Prudential Regulatory Authority (PRA) introduced changes in 2017 that mean lenders have to use stricter criteria to buy-to-let mortgages today.

A basic rate taxpayer must achieve at least 125% of their monthly interest payments from the tenant. The lender will use a nominal interest rate of around 5.5% to 6% for the calculation, even if the mortgage rate the landlord's paying is lower.

Higher-rate taxpayers must achieve 145% of their monthly interest repayment from their tenant. This is purely down to the higher implications of the tax they'll pay. It then ensures the rental income is sufficient to cover expenses, such as repairs, non-payment, service charges, etc.

Without actual figures to base these calculations on, these affordability calculations can seem ambiguous. But knowing how a lender will apply their stress test puts you in good stead when you apply for the loan. On that note, let's walk through an example:

Example: stress test calculations using SICR (or our calculator)

In this example, we'll use the stress test to see if your rental income is viable. The typical stress test uses a Stress Interest Cover Ratio (SICR) of around 5.5% and a Rental Cover Rate of between 125%-145%.

We’ll base this example on a mortgage of £200,000 with a nominal stress rate of 5.5% and rental cover at 145% (higher rate taxpayer). By working out the annual interest vs income, we can see if your figures work.

Step 1: work out the annual interest

Annual interest = loan amount (£200,000) × stress rate (5.5%) = £11,000

Step 2: work out the minimum annual rental income

Minimal annual rental income = Annual interest (£11,000, as above) × rental cover (145%) = £15,950

This means that the minimum monthly rental income you need is £15,950/12 = £1,329.17

Use our buy-to-let rent calculator to walk through different scenarios. By applying different stress rates and rental cover rates, you can work out what you need from your tenant to make the mortgage viable.

What happens if I fail the stress test calculation for rental income?

The more rent you can achieve, the greater your financial security. This is important. Buying property to rent out can become infectious, and quickly. Once you own one property, you will want another.

But let’s not run before we can walk. For your first property, rental income must be at least 25% more than your mortgage interest repayment. Or, as a bank likes to express, the tenant must pay at least 125% of your repayment.

But, as mentioned above, some lenders look for a rental calculation of 145%.

As a quick example, let’s say your monthly mortgage repayment is £800/pcm. To  meet the lender’s rental yield criteria at 125% or 145%, you'd need to get:

• at 125%: at least £1,000 rent (£800 × 25% = £1,000);
• at 145%: at least £1,160 rent (£800 × 45% = £1,160).

And if the rental income calculations don't quite work

Don't panic unduly if the rental income doesn’t quite cover the mortgage interest repayments. As we said before, some specialist buy-to-let lenders will consider "Top Slicing".

If you're a limited company or umbrella contractor, some lenders can be swayed by your day rate. But not all. Leverage your relationship with a specialist contractor broker (like us) to approach these specialists on your behalf.

You want the lender to be confident in your ability to meet the repayments and make a decent profit. Buy-to-let isn't like residential lending. It can be a minefield.

What will help your cause before approaching a lender is having one or all of these at your disposal:

• an existing portfolio of investment properties;
• the ability to stretch to a bigger deposit;
• committing to a longer initial fixed-rate period, such as a 5-year fixed over a 2-year fixed.

The stronger your hand at the start of the process, the more receptive a lender will be.

What deposits attract the best buy-to-let mortgage rates?

The least deposit you'll need for a buy-to-let mortgage is 20-25% of the property’s value. But don't stop at that if you have wiggle room. You'll get better deals at more lenders if you can up the amount you can put down.

These cheaper rates kick in if you can save 40% deposit (60% LTV). You can visualise how different deposits work using our buy-to-let mortgage comparison calculator.

Key demographics: your tenants and location

It's imperative you do your homework on your preferred tenants before you buy your investment property. Not only the building itself, but also local amenities will decide what type of tenant will want to rent your property. 

Once you've worked out your tenant, you can work out your location. Only with these two criteria filled should you buy your property. 

The one caveat to this is if this is your first property. You might underestimate how much of your free time it takes to get your property ready for rental. It would be horrible if the distance from where you live put the dampeners on your first investment venture.

Tenant vs locale: a quick tick-sheet exercise

When you consider your potential tenants, think of the local amenities that would best benefit them: 

• students/HMOs offer long-term rental in university catchment areas;
• young families will want to be close to good schools;
• young professionals will want easy-access commuting, but also decent nightlife on hand;
• bus routes and local shops are key to attracting pensioners;
• and be close to hospitals if it's nurses and junior doctors you're aiming for.

Matching location to target rental prospect is essential if you want to make property investment a success. 

Estate agents in the area you wish to buy are a great resource. Not only can they point you towards potential properties, they'll also know the local rental market. This can help both financially and with the effort you put into finding the right property.

Location and your mortgage lender?

It's not only your tenants' considerations you need to consider when choosing its location. For any tenant, the better connected, more suitable or more desired the location the better. 

This is not only true for your tenant, but your mortgage lender, too. They will also demand security for their investment.

The more up-and-coming an area, the greater the potential for long-term capital appreciation. That’s on top of the greater yield for you whilst you own and rent the home.

But also, the opposite is true. The less desirable an environment, the more barriers a lender is likely to present. Their concerns may be:

• high-rise, multi-storey buildings;
• flats above commercial premises, e.g. kebab shops;
• premises above betting shops.

All these factors will influence a lender's decision to offer you a mortgage or not. It’s not impossible to secure less desirable properties. But if you’re prospecting in those areas, you will have fewer borrowing options.

Tax and Fees on buy-to-let

There are taxes and fees you need to budget for besides the mortgage deposit and potential refurbishment costs. Some won't be applicable to you; others will. Here's an overview of your potential outlay:

Stamp Duty Land Tax on buy-to-let properties

If your investment property is any of the following, you'll pay 5% more than residential Stamp Duty:

• a buy-to-let,
• is a second home,
• is managed through a limited company.

To work out exactly how much Stamp Duty you'll owe, use our buy-to-let Stamp Duty calculator.

Income tax on buy-to-let properties

You have to pay tax on any rental income you receive from your investment property. How much you owe depends on your tax band:

• Basic rate: 20%
• Higher rate: 40%
• Additional rate: 45%

There is a cushion, as you will have allowable expenses you can deduct from your taxable rental income. You must then declare everything on your Self-Assessment tax form.

Allowable expenses include:

• Basic-rate taxpayers get tax relief on the interest on buy-to-let loans;
• A plethora of property-related expenses, such as repairs and maintenance but not large improvements, like extensions;
• Professional, legal and management fees, e.g. letting agency fees and ground rent;
• Insurances, such as building and contents cover;
• Costs for advertising for new tenants;
• Council Tax, especially pertinent where local authorities apply double Council Tax.

Capital Gains Tax (CGT) on investment properties

When you sell your investment property, any profit becomes subject to Capital Gains Tax. By extension, you'll only pay tax if the property sells for more than you bought it.

If you bought your home for £350,000 and sold it for £425,000, you'd only pay CGT on the difference, i.e. £75,000.

Again, how much CGT you'll pay will depend on your tax band:

• 18% for basic rate taxpayers;
• 24%  for basic rate taxpayers.

If your gain on the property is substantial, the profit may take you into the higher-rate tax threshold. If you're unsure whether this affects you, there's more detail on what you pay CGT and how on this government website.

Do you pay inheritance tax (IHT) on investment properties?

You pay inheritance tax on all property you own. How much you pay on your buy-to-let property depends on your circumstances. 

If you're the sole landlord and you own everything in your estate, you'll pay IHT on equity (or combined estate value) above £325,000.

You get double the allowance if you're in partnership with your spouse/civil partner. That means you'll pay IHT on anything in excess of £650,000.

The rate you'll pay is a whopping 40%, but IHT isn't straightforward. We'd advise everyone to get advice from an IFA when it comes to inheritance tax.

Selecting a letting agent for my buy-to-let property

Whether you choose to manage your investment property yourself or choose a letting agent will depend on your circumstances. For around 10-15% of your rental income, a letting agent can:

• search for the right type of tenant you're looking for;
• carry out the grunt work of legal and credit checks on potential tenants;
• maintain the property in the manner you rented it out;
• Handle the tenants' payments for you.

If you’re experienced or have time on your hands, nothing's stopping you from managing the investment property yourself. That way, you get to keep all the rental income that won't be subject to income tax.

Buy-to-let insurance

There's no law that says you have to take out landlord's insurance. But most buy-to-let lenders won't lend unless you have it in place before the mortgage completes.

You'll want your landlord insurance to cover:

• Any damage your permanent fixtures and property structure incur;
• Major rebuild costs arising from fire, flood, vandalism, storm or subsidence;
• Any furnishings you own included with your property;
• Property owners’ liability: make sure you own this before a tenant steps through the door of your property;
• Loss of income (rent) if your property becomes unfit/unsafe after a major event like flooding or fire;
• Legal expenses, should:
  • disputes arise with your tenants, e.g. costs in a liability case costs;
  • you need to take legal action to evict tenants;

You may also consider rent guarantee protection. This would cover you if your tenant remains in your property, but is not paying rent.

Take your landlord's responsibilities seriously

As a landlord, you must take every feasible step to protect your tenants. Your legal responsibilities include:

• first, make sure your tenant actually has the right to rent your property (England);
• provide your tenant with the “How to Rent” checklist from the outset (in physical or digital format);
• eradicate any health hazards from your property;
• fit working smoke alarms on every floor;
• in rooms where you have solid fuel-burning appliances (coal, wood, etc.), you must fit working carbon monoxide detectors;
• any furniture you supply as fittings must meet fire safety standards and have their labels on display;
• keep the water supply in working order and free from Legionella/water-borne viruses;
• ensure all gas and electrical equipment are safely installed and maintained;
• order an Energy Performance Certificate that shows the property's energy efficiency (and where it can be improved);
  • (more about EPCs immediately below this list);
• use the government's scheme to protect your tenant’s deposit.

Current and future EPC requirements for landlords

By 2030, the government expects that all new rental properties will have an EPC rating of ‘C’ or above. This target has been put back from 2028 by the new Labour government.

Currently, properties only require an EPC rating of E or above. However, existing tenancies have seen their EPC target of C brought forward to 2025 (from 2028).

How buy-to-let works for contractors; a recap:

We want to make sure that we’re right for you and vice versa. To that end, here’s a concise overview of what you need to know and what you can expect from us; we:

• can assess your mortgage affordability using your gross contract rate and/or rental assessment;
• can arrange buy-to-let mortgages for first-time landlords and those who already own properties;
• offer low broker fees, with no hidden charges;
• can offer you a same-day “Agreement in Principle”;
• promise you a quick turnaround, often delivering buy-to-let mortgage offers in a week;
• can access buy-to-let mortgages up to £5,000,000;
• are 100% independent, so can access the whole buy-to-let mortgage market on your behalf;
• can arrange limited company buy-to-lets at competitive interest rates;
• Will assign you a case manager, who'll keep you informed and updated on the progress of your application every step of the way.

Next step: stack the odds in your favour

As you can tell, many variables can affect your status as a buy-to-let landlord. That’s why you need a knowledgeable, flexible mortgage specialist who also understands contracting!

So, what’s your next move? This guide is generic, trying to take in different perspectives. While parts of it apply to you, not all of it will. That's why you need a personalised quote that reflects your exact situation.

The only way we can confidently advise your next move is by you talking to one of our experienced advisors. 

Like you, they’re independent professionals. They know what you’re going through from a business perspective. And it’s they who’ll undertake an initial, no-obligation assessment based on your unique situation. That's a key step in plotting a successful journey to becoming a landlord.