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Categories: Case study | buy to let mortgages | second charge
Summary of the case
- Owner occupier landlord with small portfolio
- Capital raising was needed for EPC improvements on their buy to let
- Current buy to let mortgage was still within its initial rate period
What we achieved for the client
- Raised the full amount of capital to cover EPC upgrade costs
- Re-sourced deal when rates were pulled mid-process
- Found a deal only 0.01 percentage point different to the original deal
Contents
Second charge buy to let scenario
Why raise capital for buy to let?
What is the initial rate period of a mortgage?
Can I change my buy to let mortgage before the end of the initial rate period?
How to raise capital from a buy to let but avoid paying ERC’s
What is a further advance on a buy to let mortgage?
What is a second charge buy to let mortgage?
Why take out a second charge buy to let?
Using a second charge to overcome tightening buy to let affordability calculations
Second charge buy to let scenario
An existing client approached us to raise capital, with a view to upgrading their property. Conscious of the requirement for all rental properties be rated “C” for Energy Performance by 2025, and with an overarching objective of upgrading the property to maximise rental income, the client had a specific figure in mind needed to do the work required.
The client came to us during a period of significant change in the buy to let mortgage marketplace. Mortgage interest rates were going up, and mortgage affordability calculations were becoming stricter.
Clients were starting to find that they could not achieve the borrowing they needed, based on the rental income being generated from their properties.
This change in the market impacted our client.
We investigated two possible borrowing solutions. The first being a further advance with their existing lender.
The second option was to identify a second charge buy to let mortgage to raise the funds.
Why raise capital for buy to let?
It is common for a landlord to remortgage at the renewal date of their mortgage and raise capital to reinvest in another property (where there is available equity), make upgrades to the property or for some other purpose.
However, raising capital for buy to let becomes tricky, if the mortgage is still within its initial rate period, or if changes in the mortgage marketplace, like stricter underwriting rules (which have occurred at the time of writing and were also influential when the Prudential Regulation Authority made changes to underwriting back in January 2017), affect the amount a client can borrow.
What is the initial rate period of a mortgage?
The initial rate period of a mortgage is a set timeframe, from its start date, within which a lender will offer a special mortgage interest rate. The quid pro quo for the special rate is that, if you choose to change your mortgage and move it to another lender, you will often have to pay an Early Repayment Charge (ERC). This is a penalty for repaying the debt early.
You might wonder why you are penalised for repaying early, as it sounds on the surface to be a good thing. However, the mortgage interest rate has been calculated with the income from that interest in mind. If that income to the lender is lost, it has to be recouped in some way. This is why ERC’s are charged.
Can I change my buy to let mortgage before the end of the initial rate period?
You can change your buy to let mortgage before the end of the initial rate period, but you may be subject to Early Repayment Charges (ERC’s) described above.
Some mortgages do not have ERC’s, and you can see whether yours does by looking at your buy to let mortgage offer document.
How to raise capital from a buy to let, but avoid paying ERC’s
There are alternatives to a buy to let remortgage to raise capital. If you have equity in your property (the money you have in the property is a significant percentage of the property value, e.g. 40% or more) there are a couple of ways you could raise capital:
What is a further advance on a buy to let mortgage?
1. A further advance on a buy to let mortgage is where you ask your existing lender to increase the amount of money you borrow from them.
The extra borrowing will not be added to the existing mortgage, it will instead be put on a new product.
Depending on the deal, you may be charged a product fee.
You won’t usually pay legal fees, because the lender is already familiar with the property, having undertaken checks on it when you first took out your mortgage with them.
What is a second charge buy to let mortgage?
2. A second charge buy to let mortgage is where you take out a second mortgage product, similar to a further advance (see above), but this time with a different lender.
Depending on the deal there may or may not be a product fee.
As a second charge buy to let is always with a new lender, who doesn’t know the property, there are legal fees involved.
Second charge buy to let mortgages typically have a higher interest rate than a first charge buy to let mortgage (i.e. the original borrowing on the property).
This is because, if the mortgage debt was not being paid and the lender had to repossess the property and sell it to cover the debt, the first charge lender would be repaid before the second charge lender. This carries more risk of those funds not being repaid, so the lender has to charge a higher rate of mortgage interest to mitigate against that risk.
Why take out a second charge buy to let?
A second charge buy to let might be the only available solution to you, if you need to raise capital, or the most cost effective solution available to you, if you need to raise capital.
Whilst the mortgage interest on a second charge buy to let is typically higher than a first charge, you do not have to take out a second charge buy to let mortgage indefinitely.
Once your renewal date is due, you may be able to pay off the second charge buy to let by remortgaging.
Using a second charge to overcome tightening buy to let affordability calculations
The outcome of our investigations for the client in this case study were that, based on the rental income, we could only raise 72% of the sum the client was looking for, if we went for a further advance solution.
A second charge mortgage enabled us to raise the full sum the client was looking for, but the mortgage interest rate was higher.
Faced with the need to raise the full amount, the client opted for the second charge buy to let mortgage.
This was not the end of the challenges with this case. After identifying a fixed rate deal, the lender pulled the product and we had to find an alternative. We managed to secure a lifetime variable product at a rate that was 0.01 basis points different to the fixed rate deal.
