Investing in property is widely considered an excellent way to spend money.
When you get a mortgage to do this, two of the main options are a residential or buy to let mortgage.
You should know the differences between these two types of mortgages before making a decision.
Residential mortgages
A residential mortgage is the most common type in the UK.
You use it when buying a property that you plan to live in.
If you don’t have the funds to cover the entire purchase price outright, then a mortgage makes up the difference.
Different types of residential mortgages
There are two main categories of residential mortgage:
- Fixed rate: your interest rate does not change for the term agreed (usually two or five years).
- Variable rate: Your rates will change according to internal or external factors.
Lesser known forms include:
- 95% mortgages: When you are only able to make a 5% deposit.
- Guarantor mortgages: This is when a loved one covers missed payments, should that situation arise.
- Joint Mortgage: If you are buying the property with someone else.
Buy-to-let mortgages
A buy-to-let mortgage is taken out to buy a house that you won’t live in.
Property investors do this when they plan to let out the house. You only pay back the interest on the mortgage. You don’t build up any equity.
Different types of buy-to-let mortgages
Yes, there are different types of buy-to-let mortgages.
Most are ‘interest only’ – meaning that you only pay back the interest on your loan and nothing else.
But, you can also get other types of buy-to-let mortgages. This includes a fixed, variable, tracker, discount or capped interest rate.
You should speak to your bank about whether they offer these products and what each one involves.
You usually need a license to renting out a House in Multiple Occupation (HMO). A specific mortgage is required as well.
If in doubt, you should speak to a mortgage advisor who can guide you on all the options available.
Key differences between residential & buy to let mortgages
1. Size of deposit
To get a residential mortgage, a 10% deposit is usually enough. Some lenders even accept a 5% deposit.
Meanwhile, buy to let mortgages require a larger deposit. Most lenders expect at least 25% down on the house. And some expect more.
2. Building equity vs interest-only
With each repayment on a residential mortgage, you build equity in the property.
This happens slowly at first, but much faster in the second half of the full mortgage term. You can thus eventually own the property outright, and/or get this equity back when you sell.
Meanwhile, buy to let mortgages are interest-only. This means that the monthly repayments are comparatively lower.
But you don’t build up any equity in the house. You’ll only benefit from monthly rent payments, plus any growth in property value.
3. FCA regulation
All residential mortgages are regulated by the Financial Conduct Authority (FCA).
This means that strict guidelines must be followed about lending criteria.
Meanwhile, buy to let mortgages are generally not regulated.
The criteria thus isn’t as strict. Yet, larger deposits are often needed to counteract this.
4. Who can take one out
A residential mortgage is only taken out by individuals.
Whereas, a buy to let mortgage can be taken out by either an individual or a company.
5. Whether you’re allowed to live there
You’re allowed to live in a property when you take out a residential mortgage.
Indeed, that’s the sole purpose for taking it out!
Meanwhile, you’re not allowed to live in a buy-to-let property that you own.
The amount you can borrow is based on the rent you charge. It’s not about your salary.
6. Limit to the number you can take out
There’s no limit to the number of residential or buy to let mortgages you can have in general.
But, most residential lenders will let you have any amount with the same bank, if you can afford it.
This isn’t true with buy to lets, where a lender limits you at five in most cases, no matter what.
7. Share of overall mortgage market
In a recent calendar quarter, 60.86% of all mortgages in the UK were residential.
In the same period, 6.96% of all mortgages in the UK were buy to let.
8. What happens once the mortgage term ends
When you’ve paid off a residential mortgage in full, you own the house outright.
The monthly repayments go away. It’s up to you how to proceed.
When a buy to let mortgage ends, you can either pay off the rest of the property so you own it outright, or you sell it.
Most people choose the latter option so they can cash in. The first option might be too expensive.
9. Affordability
Residential mortgages tend to need a smaller deposit at the start.
From then onwards, your monthly payments are higher. This is because you’re paying interest and also building equity.
For a buy to let mortgage, the deposit is larger.
But these are interest only, so the monthly payments tend to be smaller. Keep in mind there are some exceptions to this rule.
9. What lenders offer
Most lenders offer both types of mortgages, although not all. You’ll find some that specialise in one or the other.
Lending criteria could vary per bank or building society. And interest rates may change as well.
You should do research into specific organisations. This confirms that they offer what you need. A mortgage adviser could also guide you.
