Home truths: Buy to let

Bricks and mortar look solid, but the cracks can run deep

Everyone knows the obvious pitfalls of buy-to-let. You find a property, raise the mortgage, advertise for tenants – and the problems begin. Noise. Damage. Illegal activities. Tenants who vanish in the night, taking a month's rent with them. But these are a speck on the horizon compared to the potential financial tripwires awaiting novice landlords.

Everyone knows the obvious pitfalls of buy-to-let. You find a property, raise the mortgage, advertise for tenants – and the problems begin. Noise. Damage. Illegal activities. Tenants who vanish in the night, taking a month's rent with them. But these are a speck on the horizon compared to the potential financial tripwires awaiting novice landlords.

After five years of the buy-to-let scheme, there are 150,000 such properties in Britain, 7 per cent of the rented market. Low interest rates have fuelled this increasingly attractive alternative to the soggy stock market of the past 20 months. Building societies and other mortgage lenders certainly think so. They have leapt on the bandwagon with enthusiasm, offering a panoply of special deals and introductory discounts. The Mortgage Operation is offering a one-year rate of 3.25 per cent, and Northern Rock is charging the same until the end of 2003, if you put up half the money yourself.

And there lies the catch. Either you must find a large chunk of money, invariably at a higher interest rate, or your sums suddenly turn sour when the honeymoon period is up. Of course, you should build that into your cash flow projections, but the part-time landlord trying to invest a few hundred thousand can easily forget that sort of detail.

At best, buy-to-let lenders demand at least 15 per cent of the purchase price as a deposit, and 25 per cent is normal. If you do not have it in the bank, you have to raise it elsewhere, and your buy-to-let lender will want to know if you have done so. Lenders will expect you to show rental income of at least 30 per cent more than the mortgage payments. You may also have to prove that you already own your own home.

The US terrorist attacks have caused their share of havoc at the upper end of the buy-to-let market. There are fewer corporate tenants as international companies pull back. But even at the bread-and-butter end, people who cannot sell their houses are putting them on to the rental market, pulling down prices and rents.

As the owner, you are responsible for insuring the structure of the building, which includes permanent fixtures and fittings and, perhaps, furniture, too. Insurers are not too keen on covering you for what a bunch of students may do to a sofa over a year. Fire and safety standards must be up to scratch, and you are legally obliged to check gas appliances annually.

Although your costs of running a buy-to-let property are tax-deductible, as a private landlord if you make a profit when you sell the property, it will be liable to capital gains tax. The alternative is to buy the property in the name of a son or daughter, then act as a guarantor on the mortgage. Many lenders are unwilling to consider this kind of loan. But as the property will be your child's principal residence, there will be no capital gains tax to pay when you sell.

There will also be income tax on rents, minus expenses, such as interest payments and property maintenance. Unless you have the time to spare on this sort of investment, you may for now be better off buying a good-quality corporate bond.