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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.
Buy to Let Mortgage Calculator
Use our Buy to Let mortgage calculator to find out how much you can potentially borrow to purchase a buy-to-let property. Please note that the figure provided by the calculator is for illustration purposes only. The exact amount you will be able to borrow can vary from lender to lender, and will be based on your individual circumstances, income from all sources (including rent), your tax band, credit history and the type of property (for example, standard residential property or HMO). To discuss your buy-to-let mortgage needs in more detail, give us a call today.
Calculating affordability on buy-to-let mortgages
Current rules imposed by the Financial Conduct Authority and the Bank of England mean that lenders now have to go further to assess affordability when someone applies for a buy-to-let mortgage, with extra diligence required in the case of landlords who own four or more properties. In short, lenders have a responsibility to “stress test” assessments to be sure that the mortgage would remain affordable even in the event of future interest rate increases, and in the case of portfolio landlords they will look at the portfolio as a whole, considering factors such as the total equity and rental income across all properties owned.
Buy-to-let lending criteria can vary significantly from one lender to the next, but is generally based on the projected rental income exceeding the mortgage interest by a set ratio – for example, the monthly rental income should be 125% of the mortgage interest, usually calculated at a higher “reference rate” rather than the actual interest rate of the mortgage product you are applying for. The rental income percentage may be determined by assessing other factors including your total annual income from all sources (including rent) and your current tax liabilities. For example:
- Minimum rental income of 125% of mortgage interest, calculated at a reference rate of 5% for applicants with a total income of under £40,000 and who are non-taxpayers or basic rate (20%) taxpayers.
- Minimum rental income of 140% of mortgage interest, calculated at a reference rate of 5.25% for applicants with a total income of over £40,000 or who are higher (40%) or additional rate (45%) taxpayers.
Some lenders may refuse to lend on certain types of property, for example houses in multiple occupation (HMOs). For those lenders who do lend on HMOs, you will likely find that an even higher rental ratio and reference rate will be used to assess affordability, for example 170% at 6.5%.
New rules for portfolio landlords
Under new Bank of England rules from 1 October 2017, lenders are required to conduct much deeper affordability assessments into buy-to-let mortgage applicants who own four or more properties, even if the mortgages on existing properties are held with other lenders. These rules apply regardless of whether the landlord owns the properties on an individual basis, or through a limited company.
The rules say that applicants will have to provide financial information on all the properties owned. The lender will then assess the property portfolio as a whole, considering the total number of properties, their value and the total amount owed on existing mortgages. They will also consider the total rental income (and any other sources of income) and where your properties are located. As a rule of thumb, the lender will look at the total borrowing, equity and loan-to-value (LTV) ratio aggregated across the entire property portfolio, not just on the property you are applying for a mortgage against.
How Just Mortgage Brokers can help
Our team of expert mortgage brokers have years of experience in helping our customers get buy-to-let mortgages. We have access to deals from across the UK mortgage market, including smaller lenders who specialise in buy to let. Contact us today to discuss how we can help you find the lender and mortgage that are the best fit for your individual circumstances.