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How lenders establish buy-to-let affordability
Calculating the affordability of a buy-to-let mortgage is important in two ways: mortgage lenders will use an affordability assessment in calculating how much they will let you borrow, and – perhaps more importantly – it is a vital measure of how profitable the buy-to-let property will be. If you get your sums wrong, it could be the difference between making a profit and making a loss.
Whenever anyone applies for a mortgage, the lender will carry out an affordability assessment. For a standard residential mortgage, this involves assessing the applicant’s verifiable income as well as any monthly outgoings, such as existing credit commitments. These factors, in combination with external credit reference checks and internal credit-scoring processes, determine whether the lender will approve the mortgage application, and how much the applicant can borrow.
When it comes to buy-to-let mortgages, however, a different approach is invariably used. Instead of basing the affordability calculations on salary and existing commitments, the lender will usually compare the projected rental income generated by the property, with the mortgage interest payments. What this means in practical terms is that they will be looking for your rental income to be more than the mortgage interest by a certain margin.
Until recently, most mortgage lenders would typically look for rental income to be 125% of the mortgage interest payment as calculated at a predetermined interest rate of 4.99%. However, at the beginning of 2017 the financial regulator, the Prudential Regulation Authority (PRA), set down tougher rules on buy-to-let affordability assessments. Now it is more common for buy-to-let lenders to look for rental income to be 140% or 145% of the mortgage interest payment and now at a predetermined rate of between 5% – 5.5%. Certain types of buy to let, such as borrowing to purchase a House in Multiple Occupation (HMO) can see even higher affordability margins used – up to 170%.
As already touched on, the guidelines from the PRA mean that buy-to-let affordability assessments are not quite as straightforward as comparing the projected rental income with the actual projected mortgage interest payments. Instead, they require buy-to-let lenders to “stress test” affordability. That means that in most situations rather than using the actual interest rate of the mortgage that you are applying for to assess affordability, the lender will use a predetermined interest rate that assumes a future interest rate rise. The purpose of this is to ensure that your ability to repay the mortgage based on the rental income will remain even if the economy changes and interest rates start to increase.
The stress-testing rules mean that, unless the mortgage product’s interest rate is fixed for five years or more, lenders should base their buy-to-let affordability calculations on the higher of:
- A hike of at least 2% above current rates
- Market projections of future interest rates
- A minimum stress-test rate of 5% – 5.5%
Example buy-to-let affordability calculation
Here we will break down an example of a buy-to-let affordability assessment. Please note that this is a simplified example for illustration purposes only. After the calculation we will take a look at some of the other factors that buy-to-let lenders may take into account when calculating affordability.
In this example we will assume you are buying a property with a market value of £350,000. You are putting down a deposit of £105,000, and applying for a 70% loan-to-value (LTV) mortgage for £245,000. Applying the minimum stress-test interest rate of 5.5% gives total annual interest of:
£245,000 x 5.5% = £13,475
The monthly interest repayments on this would be:
£13,475 ÷ 12 = £1,123 (rounded up to the nearest pound)
Assuming the lender uses a 145% buy-to-let affordability multiplier, this would give:
£1,123 x 145% = £1,629 (rounded up to the nearest pound)
In this example, the lender would be looking for the property to generate a minimum projected rental income of £1,629 per month to meet the affordability criteria for a £245,000 mortgage.
The table below summarises affordability calculations for various buy-to-let mortgage amounts (based on the same assumption of a 5.5% stress-testing rate and a 145% affordability margin).
Other factors lenders may take into account
If you have done your research, you should know before applying for a mortgage how much rent the property might reasonably demand. However, for the purposes of affordability assessment, do not expect the lender to take your word for it; lenders will typically base their calculations on a rental value provided by the external or in-house surveyor who carries out the property valuation.
Many lenders’ buy-to-let affordability assessments also take into account void periods – a typical approach is to assume that there will be one month out of the year that the property will generate no rental income, and this is taken into account when carrying out the affordability calculation.
Lenders may also factor property-related expenditure into the affordability calculation, deducting this from the rental income. Expenditure that lenders typically take into account – and that you should also account for when working out the affordability of a buy-to-let property – include:
- Letting agent fees (usually around 10–15% of the rental income)
- Landlord insurance
The cost of any regular safety checks (including gas, electrical and fire safety)
Any maintenance and repair costs
A final consideration is the lender’s maximum loan-to-value (LTV) limit. The LTV places an absolute cap on the amount a lender will lend on a property, regardless of rental income. For buy-to-let lenders, a maximum LTV of 75% is typical, though some lenders do offer higher LTV mortgages. Be aware that many lenders also price their mortgage products in LTV tiers; if you are able to put down a larger deposit or borrow less against the value, you may qualify for more attractive interest rates.
No two lenders are alike
The buy-to-let mortgage market is a lot more diverse than the residential market. There are a lot of smaller lenders who specialise in offering buy-to-let mortgages, and even the mainstream lenders can differ quite considerably in their policies and procedures, and in how they assess buy-to-let affordability.
Different lenders have different maximum and minimum lending limits, and can also vary in their approach to lending on certain types of properties; for example, many lenders refuse to lend outright on properties of a non-standard construction.
It is also common for lenders to cap the total amount of buy-to-let lending to an individual. This has the potential to be problematic if, for example, you have a large portfolio and have all your mortgages with a single lender, or with lenders within the same group of companies (for example, Halifax, Bank of Scotland and Lloyds are all part of Lloyds Banking Group).
How Just Mortgage Brokers can help
At Just Mortgage Brokers we have many years of experience working with lenders of all sizes, from the high-street banks to more specialist lending companies. We understand the intricacies of buy-to-let affordability assessment, and can help ensure you get the mortgage that is right for you, with the lender that best suits your needs. Get in touch with us today to discuss how we can help you get a buy-to-let mortgage.