13 Jul Buy To Let Mortgage Deposit – Do we really need one?
Buy To Let Mortgage Deposit – Do we really need one?
A deposit is required for purchasing with a buy-to-let mortgage. For a buy-to-let remortgage then you will more likely be using the equity in the property as the effective deposit amount. On a purchase, the buy to let mortgage deposit effectively creates instant equity, so these are essentially the same thing.
Of course, with a remortgage, if there is insufficient equity in the property for some reason, such as market values have fallen since purchase or last remortgage, then you will need to pay the difference that the equity is lacking based on the loan-to-value (LTV) of the proposed loan. Another possible reason for a shortfall in equity required for the remortgage could be a lower LTV in the new mortgage offer. This could be lower than was used on the present mortgage you are switching from, and assuming insufficient increase in property value in the meantime to make up the difference.
The reason there needs to be a buy to let deposit payment (for a property purchase) or sufficient equity in the property (for a remortgage) is for the financial protection of the lender who takes a legal charge over the property being mortgaged. The lender will need to ensure that if you default on your loan payments then they can sell the property quickly. The price they get should at least recover the capital they have loaned to you even after all costs of selling are taken into account, which are charged to you as well of course. They will also want to do this quite quickly, assuming that the reason for their repossession is for lack of receiving their due monthly mortgage payments.
Lack of receiving these monthly mortgage payments means they are losing money as each month goes by, because they are not getting paid at least the interest owing to them for lending out the money. In order to sell the property quickly, they will typically need to reduce the price to be attractive and achieve a quick sale.
This means, in effect, that they will be willing to forgo the equity in the property (your equity, including any or all of your deposit) in order to sell quickly and get back at least their loan capital. They may even be prepared to lose some of their own capital in return for a definite and quick sale. This is not something they will plan to do of course and they have a duty-of-care to show they tried to get the best price for the property, accounting for the time constraint they are under to sell.
The buy to let mortgage deposit financing, or equity in the property, will also protect you as well as the lender. This is in the sense that if you did get into some difficulties in servicing the loan (paying the monthly payments) then you should also be able to sell quickly before repossession takes place by the lender. Of course, this would follow the similar route as described above and you would therefore lose some or all of the buy to let deposit/equity in the property. However, at least you would not have to find money to put in to pay off the mortgage.
Problems arise in forced repossession when there is no effective equity in a property. This can more easily occur during a downturn in the market. It is the inability of the owner to find money to pay off the mortgage balance that creates the problem. This is where the proceeds from the sale will be less than the loan amount and this leads most people into repossession proceedings with the lender.
The best way of avoiding this situation is to respond to early warnings if you are having difficulty in paying a mortgage, you can then off-load the property before it becomes over-burdensome. If you leave it too late you may then need to lower the price for quick sale. Then, to avoid repossession, you would need to find the additional funds to pay for the difference in sale proceeds to mortgage settlement figure.
The term commonly used for describing this situation where you don’t have enough equity to cover the loan amount is negative equity. This is where the sale value of the property is lower than the value of the loan secured on it. This assessment of being in negative equity is based on the normal market value of the property.
However, when there is reason for a lowering of the price to achieve a quick sale then this situation suddenly becomes even worse. Therefore, the urgency to sell really has a bearing on whether you are really in negative equity or not, or how much negative equity you are in. This is why it is beneficial to both the lender and you, as the Property Owner, to have a sufficiently large buy to let deposit or enough equity in the financing, to prevent this situation from arising.
Another softer reason for putting a buy to let deposit into a purchase, or keeping equity in a property on remortgage, is that this prevents property investors from getting greedy. Without this they could just be taking on more and more property debt and without risking any of their own money. Well let’s say, at least on the face of it not risking any of their own money, because of course the largest risk would be personal bankruptcy! This is because they will still be responsible for the full loan amount even if they have none of their own money invested in the property.
This is something that happened a lot in the early to middle noughties when there were such things as gifted deposits widely available from developers. This enabled investors to buy without using their own deposit funds, instead using a builder’s reduction in property price against list price as the deposit. Well, this meant investors could buy and buy repeatedly with mortgage lending only, and some did! Then when the market crashed and/or the rents they were supposed to generate did not materialise, such people investing heavily this way quickly went bankrupt.
I was also on that particular investor bandwagon for a while until I realised the error of my ways and stopped after purchasing just four new-build apartments that way. If I had gone much further, I would have been bankrupt for sure. Such deals look attractive but the mortgages on these deals are often hard to service as the rental income hardly covers the monthly interest payments. On top of this, there are additional expenses that then cannot be covered. This is all even though the projections showed all was well and mortgage lenders were happy with it for mortgaging purposes.
It was also doubtful that buying this way gave genuine equity, as nearly all of the new property sales were being made the same way. If almost everyone is getting a discount of the same amount is this really a discount at all? This was however accepted by the Valuers doing the mortgage valuation and so the deal went through giving effective 100% financing!
You don’t even need a market crash to go bankrupt in this situation, a crash can exaggerate it however. You then end up in massive negative equity and if rents or other income can’t support these and then you will go bankrupt if you can’t finance the mortgage payments or mortgage debt from other sources. Such builder full-amount gifted-deposit deals are no longer around and are no longer acceptable to lenders anyway, but just be aware of this just in case these deals ever return!
Therefore, see the need for a buy to let mortgage deposit, or genuine equity in a property, as a good thing and something you should welcome as it can protect you financially as well as protecting the lender. Buying the right deals in the first place is the cornerstone of achieving this protection… buyer beware!
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