What is the Buy to Let Stress Test?
When applying for a buy to let mortgage, you will need to pass a lender’s buy to let stress test rather than simply prove that your rental income will cover your monthly mortgage repayments.
The income cover ratio test is the calculation lenders apply to determine your affordability of a buy to let (BTL) mortgage. It compares the amount you want to borrow with the amount of rental income you’ll receive and the interest you will have to pay on the loan.
Mortgage lenders can approach this calculation differently and understand how the calculation works and which lenders offer the best calculaion can make a real difference to your borrowing capacity.
Why do Lenders Apply an Income Cover Ratio to Buy to Let Mortgages?
When measuring affordability for buy to let mortgages, lenders require a buffer in your rental income of either 125% or 145% (dependent on tax status). Set out by the Prudential Regulation Authority in 2017 this is the income cover ratio (ICR) and is applied to ensure you have enough surplus income from the property to cover any repairs and cover any potential cost rises.
Lenders will also apply a stress test to your application, factoring in your ability to pay an interest rate higher than you are currently paying.
The interest rate applied fluctuates in line with the current mortgage market and will dictate loan sizes. This is applied by mortgage lenders to enusre the mortgage size you obtain is affordable if rates were to rise like we have seen in 2022.
How Do you Calculate the Stressed Income Cover Ratio on a Buy To Let Mortgage?
A typical stress test conducted by a buy-to-let lender uses a Stress Interest Cover Ratio (SICR) of around 5.5% and a Rental Cover Rate of between 125%-145%.
However the stress rates do change dependent on the lender and the type of transaction and product chosen by you can also affect the stress test figure used.
Below is an example of how the buy to let stress test calcualtion is performed.
Loan Amount: £200,000
Income Cover Ratio: 5.5%
Rental Cover: 125%
Step 1: Work out the annual interest:
Loan amount £200,000 x ICR 5.5% = Annual interest of £11,000
Step 2 – Work out the minimum Annual Rental Income
Annual interest £11,000 x rental cover 125% = Minimal annual rental income £13,750
Or minimum monthly rental income of £1,146
How Does My Tax Status Affect Affordability?
Lenders are required to take a borrower’s income tax into account when assessing affordability for a buy to let mortgage.
Therefore your tax rate status has a direct affect on the stressed income cover ratio used to assess your BTL affordability.
Basic rate taxpayers can expect lenders to apply a stressed income cover ratio of 125% as there is less of tax liability on their rental income.
Lenders will usually assess higher rate taxpayers at a stressed ICR of 145%, while additional rate taxpayers might be assessed at up to 170%.
This means, that if you fall into the higher tax rate category you will need more rental income to achieve affordability.
As a result of this we have seen a rise in landlords turning to Limited company buy to lets, where the 125% ratio is used. Whether a limited company buy to let mortgage is right for you depends on lots of other factors discussed here.
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Speak to an Expert!
Contact us today for expert advice and guidance on your unique mortgage and property needs. We will work with you on a one-on-one to basis to help you find the right solution for your needs.
With our experience you can rest assured that you are in good hands when it comes to securing the financing you need for your property.
What Happens If I Fail Affordability?
If your buy to let property doesn’t meet a lender’s standard stressed ICR test, it may not mean your mortgage application will be refused outright. There are options that could be available to you.
This is known as ‘Top Slicing’, when a lender assesses your income, seperate to the rental income, to determine whether you would still be able to make the mortgage repayments.
Not all lenders offer top slicing so employing the help of a mortgage broker can help in this situation.
It may be that the mortgage lender you applied with was using a high stress test calculation. It is certainly possible another lender would find your application affordable, whihc is why a mortgage broker’s skills and expertise can come to the rescue.
Similarly, the type of prodcut you choose may have different stress test requirements which could be lower and therefore affordabilty increased. For example 5 year fixed products have lower calcualtions than 2 year fixed products currently.
If you are a portfolio landlord, lenders can take a wider view of your portfolio, and better performing properties within the portflio can pick up the slack of the not so well performing properties in the eyes of the lender.
What Could You Borrow on Your Buy to Let Mortgage?
When it comes to finding the best buy to let mortgage deal it’s always best to seek advice from an independent mortgage broker.
If you’re unsure if you will pass the stressed ICR test, or have had a previous BTL mortgage application turned down, we can help.