Buy-to-let mortgage gearing explained

Zarah Gulfraz

6-minute read

Last updated:

October 5, 2020

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Buy-to-let gearing simply means using a buy-to-let mortgage to buy a property. Even if you only have 1 rental property and 1 buy-to-let mortgage, you're geared.

Gearing is normally used by investors with the aim of growing both their portfolio size and their potential returns.

Is buy-to-let gearing good or bad?

It depends how geared you are and the strength of your investment.

If your properties are making you money, gearing allows you to multiply the investment potential, if things start to go wrong, like your rents not covering your mortgage repayments for instance, then your liability is multiplied too. And that's partly what lenders want to check when you apply for a new buy-to-let mortgage.

How does buy-to-let gearing increase your investment returns?

Gearing can boost both your capital return and your monthly yield.

Geared return on capital investment

Let's keep the numbers nice and simple and let's say you have £100,000 to spend on buy-to-let properties.

You could buy a £100,000 property out right and not have a mortgage – and not be geared.

  • In that case, if property values increase 5% over the next 12 months, your property is now worth £105,000 and you've made capital gains of £5,000 or 5%. Not bad.

Or you could use the same £100,000 to put £25,000 deposits down on 4 properties.

  • In this case, if property values increase 5% over the next 12 months, your properties are now worth a combined £420,000.
  • You still need to repay 4 mortgages of £75,000, which is £300,000, but your £100,000 stake in the property is now worth £120,000, so you've made capital gains of £20,000 or 20%. That's really good.

This page shows how buy-to-let mortgages, and capital gains in particular, created the best performing investment of the past 25 years.

Geared buy-to-let yields

In the ungeared scenario, let's look at yields.

  • Your £100,000 buy-to-let achieves a monthly rental income of £600, that's £7,200 a year, or a gross yield of 7.2%.

In the geared example, your 4 buy-to-lets achieve joint monthly income of £2,400, or £28,800 a year.

  • Yes… that's a gross yield of 28.8%, but let's not get carried away. You've got mortgage repayments to make with that money.
  • If you have an interest rate of 4% you'd be paying £12,000 a year back to the bank, which means you'd have a yield of £16,800 or 16.8%. That's still mighty impressive.

Risks of buy-to-let mortgage gearing

Ok, now the flip side to the gearing coin.

The first and main risk is that you can't repay the debt or make the interest payments. If that happens you risk losing your money, your properties and your chance of getting any credit in the future.

You can offset these risks slightly with insurance protection (an extra cost) that covers void periods  or just by having a contingency plan to pay the mortgage, should rental income stop.

The next risk is a decrease in property value – the reverse of what happens in the geared capital gains example.

If your 4 buy-to-let properties fall in value from £100,000 to £95,000 each,  you haven't just lost £5,000 or 5%.

The combined value of the properties is now only £380,000 and you still need to pay the £300,000 mortgage debt back. So, your £100,000 is now essentially worth £80,000, which is a loss of £20,000 or 20%.

The final problem is that landlords with big buy-to-let property portfolios may get new mortgage applications declined, as lenders see them as a bigger risk.

For similar reasons, highly geared landlords are likely to pay higher rates to be offered a lower rate with less gearing.

How does buy-to-let gearing affect a buy-to-let mortgage application?

In September 2017, the Prudential Regulation Authority (PRA), part of the Bank of England, told banks that going forward they need to ask additional questions of portfolio landlords before they decide whether or not to lend.

You're a portfolio landlord if you have 4 or more mortgaged properties, according to the PRA's rules. So, if you have 5 properties but own 2 of them outright, then these rules don't apply to you.

Equally, when totting up the number of mortgaged properties, those within a limited company owned by a landlord also count. So, if you hold 2 mortgaged properties in your own name and 2 in a company, you're a portfolio landlord.

So, how many buy-to-let mortgages can I have?

Every lender will have have their own limit. For instance, Lloyds - the UK's biggest BTL lender - tends to cap you at 5. Most mainstream lenders will get a bit twitchy when you hit the 3 to 5 mark.

If you want an even larger portfolio, you'll have to use more than one lender. However, problems can arise as some lenders will even restrict the amount of buy-to-let gearing you do with other lenders too. If you're unfamiliar with the effects of buy-to-let gearing on your mortgage application, please get in touch and speak to one of our experienced, BTL mortgage specialists.

What additional info do portfolio landlords need to provide as part of a buy-to-let mortgage application?

Each lender has their own specific guidance, but the PRA recommends banks ask to see:

  • Property portfolio spreadsheet
  • Cashflow forecast spreadsheet
  • Income and expenditure spreadsheet
  • Business plan
  • Tenancy agreements for all properties
  • As well as the standard, 3 months' bank statements, SA302s and tax overviews from HMRC

The whole point of these extra checks is to stop lenders looking at your new buy-to-let mortgage application in isolation, so they aim to show red flag risks to lenders, such as empty properties and negative equity.

Buy-to-let mortgage guides

Here's a few other articles you may find useful.

The Big, BIG Buy-to-let Guide

Thinking about buy-to-let? you'll find everything you need to know right here - from investment potential to mortgage applications.

Find out more

Want to apply for a buy-to-let mortgage as a LTD company?

It's an option that could end up saving you thousands. Especially if you are looking to grow your portfolio. Can you get a mortgage as a ltd company?

Find out more

How does tax work on a buy-to-let mortgage?

Buy-to-let investors need to deal with lots of different taxes. There’s Income Tax, Stamp Duty, Capital Gains Tax and so on, and so on...

Find out more

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