Before the 6-month rule, when the property market was booming in the 90s and early 2000s, there was a trend for investors of buy-to-lets to use day one remortgages – essentially taking out a new mortgage the day they got the keys for the property – as a way of buying property with no deposit. They would buy a property with a small 10% or 15% deposit with one lender, and take a remortgage application with another lender with a higher property valuation.
An unscrupulous solicitor could effectively put the remortgage through on the same day as the purchase, with 100% of the mortgage funds being used to make the purchase. For instance, say you bought a house for £80,000 and got a mortgage for £72,000 (yes, you really could get 90% buy-to-let mortgages back then …). At the same time, you also apply for a remortgage with a different lender but with a suggested property value of £90,000. The new mortgage was agreed at £81,000 and the funds were diverted directly to the seller, none the wiser, who was expecting £80,000. In actuality, the buyer never put a penny into the deal and technically come away £1000 up.
When the credit crunch developed, repossessions started to rise largely due to investors under financial stain ceasing to pay the mortgage. This left lenders seriously out of pocket, as they realised the prices had been wildly inflated, and the mortgage amounts they were saddled with were higher than the property was purchased for. The repossessed buyers walked away, effectively having lost nothing. As a result of this, we now see buy-to-let LTVs starting at 75%, as well as remortgages at market value, marking the beginning of the 6-month rule.
The 6-month rule meant that investors now needed to wait 6 months before they were able to modernise and renovate usually run down, poor quality housing before being able to refinance based on an improved value. This was a popular and effective method of creating a property portfolio and creating value, so the 6-month rule is seen to slow down the process, increase costs and tie up vital cash for managing a property portfolio.
Thankfully, not all lenders observe this 6-month rule. Virgin Money, Mortgage Trust, Paragon and a number of other specialist lenders will allow day one remortgages, but with one important caveat: they only allow the remortgage value to be the price paid for the property within the first 6 months.
This may not be an issue however: as an investor, you might be buying a property that needs a very minimal amount of work (for instance a property without a working cooker wouldn’t be suitable, but adding one may only be a day’s work) or where buying cash is advantageous, such as an auction purchase.
Remortgaging on day one for what you paid for the property under these circumstances allows you to complete the purchase, but then extract 75% of the price back by way of a remortgage, leaving you in the same position as if you bought outright with a mortgage.
Secondly, and more commonly, is that the property needs significant development to be lettable or even habitable, and making these improvements increases the value by a wide margin. The following example illustrates the potential returns observing the 6-month rule:
Purchase a property for £75,000 cash and spend £10,000 to develop it and make it lettable. On completion of the works, you value the property at £100,000 and wait for 6 months with £85,000 tied up. After 6 months, you can remortgage to 80% LTV and release £80,000, almost what you put in in total, but leaving behind equity of £20000. This is great, but it took a lot of upfront cash and tied it up for over 6 months.
The most common way to approach a property that is not mortgageable is to use what’s known as bridging finance, short term finance designed to, you’ve guessed it, bridge the gap between the current situation and the desired outcome. The exit, or how you are going to repay the loan, is crucial and this would usually be via a new mortgage or the sale of the property.
Bridging finance can often cost between 1% and 1.5% per month and comes with significant upfront, arrangement and exit fees that can chew through any potential profits. Having to observe the 6-month rule forces you to sit at these high rates for all that time.
A better alternative is to use a provider that offers a “bridge to let” option. In this instance, the lender will provide a bridge and then switch this to a remortgage almost immediately once the work is complete, with just a month’s interest payable as a minimum.
The bridging rates are slightly higher, but only having to pay these for a month or two significantly reduces the overall cost, and allows profits to be released sooner to take on to the next project.
Here’s an example explaining how this works:
- You buy a property in need of work for £75,000. In advance of submitting the bridge application you would need to calculate what need to be done and produce a detailed schedule of work that will be passed to the surveyor.
- You submit a bridge application for 70% of the £75k (£52,500), putting down a £22,500 deposit. The valuation is done and its confirmed that current value is £75k and improved value will be, for example, £100k.
- As soon as you receive the valuation you can submit a DIP for the BTL remortgage, based on the value of £100k.
- The bridge completes and you begin work. You can submit the BTL Remortgage application the day the bridge completes and get the underwriting started.
- As soon as you complete the work on the property you get a re-inspection, ideally having completed all the other requirements for the BTL application.
- The remortgage completes at say 80% LTV on the £100k, paying off the bridge, with the rolled in arrangement fees (often £0) and interest (minimum one month, but no exit fees) and you receive the additional money.
If we assume that the total cost of the bridge is £2,500, after the 80% remortgage has completed and fees paid (excluding stamp duty, broker fees, solicitor’s fees and any other costs outside of the finance), the cash released after completion would be £25,000, fully reimbursing you for the initial cash deposit. Cleverly managed and applied to the right properties, this seed capital can be reinvested multiple times. You don’t need to tie up £85,000 in one go or pay 6 months of bridging finance unnecessarily, and can turn the whole project around much quicker.
To add to this, it can be done in a limited company, making this more tax-efficient in many cases. If capital isn’t readily available but there is sufficient equity elsewhere, a charge can be taken over additional property and 100% funding can be obtained to buy the run-down property, meaning you don’t have to tie up any cash in initial deposit.
We hope this post has given you some food for thought. If you have some cash or equity, you can buy a run-down property renovate, release funds and move on again. There are some challenges in the BTL market at the moment but, with some creative thinking and the right advice, there is opportunity everywhere. Why not drop us a line to talk through any projects you are considering and let us give you the benefit of our knowledge and experience.