How does a buy-to-let mortgage work, and how is rental income taxed?
A buy-to-let mortgage is assessed mainly on the rent the property will produce, not on your income — and the tax treatment changed fundamentally in a way that made highly geared personal ownership much less attractive than it once was.
How lending works:
Interest coverage ratio. Lenders test whether rent covers the mortgage interest by a required margin — commonly 125–145% of interest at a stressed rate well above the actual one. This is the binding constraint, and it is why a property that looks affordable at current rates may not be lendable.
Larger deposits, typically 25% or more.
Interest-only is common, since it maximises the coverage ratio and the tax position — leaving the capital to be repaid by sale or refinance.
Minimum personal income requirements in many cases, plus restrictions on property type and tenant type.
Product fees are often higher, and sometimes charged as a percentage.
How rental income is taxed — the change that reshaped the market. Finance costs, principally mortgage interest, can no longer be deducted from rental income for individual landlords. Instead there is a basic-rate tax reduction on those costs.
Why this matters so much: the calculation now runs on rental income before interest, which can push a landlord into a higher tax band and can produce a tax bill exceeding actual profit on a heavily mortgaged property. Basic-rate taxpayers are largely unaffected; higher-rate taxpayers are affected substantially.
What is still deductible: letting agent fees, repairs and maintenance — but not improvements, which is the most common error — insurance, ground rent and service charges, accountancy, and replacement of domestic items.
Other costs to expect: a stamp duty surcharge on additional property, capital gains tax on sale at rates specific to residential property, and reporting deadlines after completion.
Why some landlords incorporate. Companies still deduct interest in full, but incorporation triggers stamp duty and capital gains on transfer, and company mortgages cost more — so it suits some portfolios and not others.
General information, not tax or financial advice.