The Effects of Interest Rates on Buy-To-Let Investments (Coursework Sample)

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The Effects of Interest Rates on Buy-To-Let Investments
Introduction
Most importantly, buy-to-let is a long-term investment that does not realize profits in the short term but provides better returns for those who choose to wait for an extended period. Buy-to-let is a terminology that originated in Britain, which refers to buying a property for the sole purpose of renting it out for a profit. For many years, property owners have invested in residential property; the rent controls enacted during WWI, arranging for mortgage designed for this purpose had been difficult. However, changes in the financial housing sector, which allowed free market controls for rental houses have increased, this has persuaded lenders to provide finances for such ventures. One of the primary benefits of buy-to-let mortgage is that it offers a steady income for the property owner in rental receipts. Essentially, the rising housing prices in the US led to a boom in the buy-to-let business as more people wish to own houses for rental purposes only. Notably, excess mortgages financed by fincnced by unsecured loan plyed a key role in the 2008 housing bubble burst. The primary risk is that property owners apply for loans to buy or build these houses with the hope that the houses would sell at a higher price in future, or the rent would be able to service the loan. However, the banks repossess the property if the owner fails to service the loan. Eventually, the investor loses the property and this ends up as a wrong decision.
The Current Issue
As noted earlier, buy-to-let investment is a common investment option in the US but the Fed believes that the system poses a grave threat to the economy. Trotman notes that creditors have found an easy access to finances, which they put in buy-to-let properties. The lax in lending standards in the sector could contribute to housing price increase as more people borrow to build or buy houses; eventually, this would cause a high household indebtedness. In the event of a depression, investors who opt to sell their houses to an illiquid market would cause a fall in the prices, which would cause defaults on mortgages. At the same time, interest rates tend to rise; however, a small increase in the rates would significantly reduce property income thus discouraging investment in properties. In particular, higher interests rates cause a drop in revenue, and failure to service the loans given that some of the creditors depend on the rental income to service their loans. Currently, buy-to-let creditors account for fifteen percent of the outstanding loans and a further eighteen percent of new mortgage flows (Mellish and Rhoden 147). Besides creditors who acquire money from financial institutions to invest in properties. Early this year, Fed announced that it increase interest rate, which will affect mortgage; this has led to a significant rise in interest rate.
According to Mellish and Rhoden, investors should be wary of the risks involved in the buy-to-let investment (183). Even though many people have invested in the sector for many years, in practice, it is more profitable during boom seasons whuich is associated with rising prices and low rates. The industry favors people with large amounts of money who are able to raise large sums of cash deposits; it enanbles them to acquire a property without borrowing from financial sector. In the last 5 yeasr, investors have taken the opportunity after the housing market has started to stabilize after the 2008 economic downturn. For instance in 2013 Atlanta housing price rose by appoximetly 18% while at national level the number of properties repossessed by banks has drastically reduced (Dryson). The investors expect the prices to continue to rise in the near future; as such, many of them hope to have made the right decisions . The current low mortgage rates is attracting investors who lack adequate amounts of cash to finance such ventures. However, Goodchild warns that interest rates would increase in future; therefore, people who invest in the sector ought to make choices that could stand the test of time (3038). For instance, banks repossessed many houses during the 2008 economic crises after mortgage rates rose.
In addition, Goodchild proposes that investors should conduct market research to determine the most viable business opportunities (3039). In essence, buy-to-let means tying up money in a property whose value might fall in the future if the economy experinces depression. In the research, prospective investors should choose a promising area. In this regard, the area does not necessarily have to be the cheapest or the most expensive. A promising area refers to a place where people would wish to live in the future for different reasons. Some of the common aspects that people look for when choosing their residential locations include transport means, schools, and other social amenities depending on the social statuses of the people who reside there. Importantly, the investors should choose a location that best suits their needs and buy a property that meets the needs of the population who live in the region. In most cases, people choose to buy real property situated close to where they live; this offers them an advantage because they understand the market trends of that area better. Nonetheless, it is imperative to explore other locations because they provide other opportunities that could be absent in one’s location.
In principle, it is important to write down the prices of the properties that one wishes to buy before going to a bank to obtain a mortgage (Mellish and Rhoden 191). In this regard, the investor ought to calculate the amount of rent that would come from the property to get an accurate return on investment figure. In this way, it would be possible to understand whether the investment would be in a position to service the loan, or the investor has to subsidize some part of the mortgage. The majority of buy-to-let lenders expect rent to cover one hundred and twenty-five percent of repayments and twenty-five percent of the deposit or more. At the same time, it is imperative to factor in maintenance costs in order to come out with an accurate figure of the amount of income that would come from the investment. Once this is sorted out, the investor should consider possible scenarios that would affect the investment in the future and design the best methods to circumvent such unforeseeable occurrences.
Moreover, as an investor, it is paramount to shop for the best mortgages in the market. Ideally, many financial institutions offer similar services but their costs are different. Reliable independent brokers are helpful in the search for a mortgage because they have a vast knowledge of the financial sector (Trotman 4). Besides the agents, the investor should conduct an independent research and compare what different financial institutions have on offer to choose the best suited to the prevailing circumstances. Additionally, the investor should study the target tenant to understand their preferences, to invest in a property that suits their needs. Some tenants wish to make their mark in the properties such as through decorations, adding pictures or removing unwanted furniture because it makes them feel more at home. In this sense, the investor should be flexible enough to allow the tenants to make some changes as long as they do not affect the value of the property.
In practice, the buy-to-let property is ideal for people who feel more secure when they purchase tangible assets as opposed to shares and stocks according to Trotman (8). The investors in this sector are ready to tie up their funds for an extended period and understand that prices could either decrease or increase. In additi...