Buy-to-let investors ought to be biting their nails as they wait to see whether the Bank of England’s Monetary Policy Committee decides to raise interest rates next week.

Although it is a year since rates last moved, a rise would increase the risks for many investors hoping a buy-to-let property will bail them out in retirement. For as the industry celebrates the tenth anniversary of the first buy-to-let mortgage, investors are already facing increasing headwinds.

Demand for rental property from twentysomething graduates priced out of the housing market remains strong in certain areas, such as London. However, the cost of borrowing has risen by more than a quarter over the past three years, from 3.5 per cent in July 2003 to 4.5 per cent now. More specifically, costs have jumped in the swap-rate market, which determines the cost of fixed-rate mortgages.

Ray Boulger, of John Charcol, the mortgage broker, says: “Over the past three to four months, we have seen swap rates go up as the market has bet that interest rates will rise. As a result, fixed-rate mortgages are about half a point up on where they were three to four months ago.”

So, having been comfortably less than 5 per cent earlier this year, the best fixes for buy-to-let borrowers come in at 5.09 per cent, for a two-year fix from MT Select, part of Paragon, and 5.35 per cent from Clydesdale Bank.

However, Melanie Bien, of Savills Private Finance, another broker, says that life has become easier for buy-to-let borrowers over the long term.

“In the past you would have been forced to pay one or two percentage points above residential rates and put down a deposit of 20 per cent to 30 per cent of the purchase price,” says Ms Bien. “Now the interest margin has been cut to about 0.6 per cent and some lenders will advance most of the property cost, with loan-to-value rates of 90 per cent available.”

The better terms are partly the result of increased competition. Alliance & Leicester is the latest entrant to the market, while Abbey has expanded its offering substantially.

Another factor is that fewer borrowers have fallen into arrears than lenders expected. Figures from the Council of Mortgage Lenders show that buy-to-let mortgages three or more months in arrears represent less than 0.7 per cent of the total. That is substantially better than the wider market, where the equivalent figure is nearly 1 per cent.

But even in the buy-to-let market, the percentage of mortgages in arrears has more than doubled since 2003. So is it safe for novices tempted by those 90 per cent loan-to-value deals? The experts advise caution.Mr Boulger says that high levels of gearing worked well for early entrants to the market. But he adds: “Those who got in more recently won’t have had the benefit of so much capital gain to fall back on if times get tough.”

Lee Grandin, of Landlord Mortgages, another broker, says: “As long as arrears and interest rates remain stable, then 90 per cent loan to value is fine. But rising interest rates with 90 per cent loan to value would create a problem for novice investors.”

A government crackdown earlier this year means some landlords will be lumbered with extra costs. Those who own a “house in multiple occupation” will have to fork out between £100 and £2,000 for a five-year licence. (For more information visit www.property licence.gov.uk.) Add the cost of renovating properties to meet the required standards and you could be looking at a 10 per cent overall increase in costs, says Paul Rockett, of the Business Mortgage Company, a specialist broker based in Cardiff. And there are more new regulations still to come.

But if the industry appears comfortable, even complacent, outsiders are more ambivalent. Philip Shaw, an economist at Investec, the investment group, is surprised by the resilience of the housing market over the past 18 months.

Investec’s analysis shows that UK households have been financially stretched by high levels of debt, a slowdown in pay rises and the increased cost of energy and utility bills. This will soon show through in the economic figures, such as housing activity, he predicts.

The main danger, however, is for new entrants who sink all their cash into buy-to-let. This lack of diversification makes buy-to-let a poor substitute for proper pension planning. The lesson is to do your homework and leave yourself a respectable safety margin.

CASE STUDY

Alex Freeland and Floyd Jebson started investing in buy-to-let property in 1993, a year after they graduated from the University of Southampton, and have accumulated a substantial portfolio, spread between Southampton and London.

The London-based duo take a long-term view of the market, rather than taking punts on changes to interest rates. Alex, far left, says: “A short-term view can work if there are dramatic market fluctuations, but people tend to act too quickly to news of oil prices and the possibility of a global market downturn.

“During a period of sustained equilibrium and low fixed-rate mortgages, which is what we have now, there is no need to dip in and out of buy-to-let property.”

The pair began investing with a view to retiring on the proceeds of their properties. But now Alex says: “We are reaching a point where it seems wise not to put all our eggs in one basket. We have both set up personal pensions and intend to start making other retirement savings.”