A stress test is used by all lenders when assessing the suitability of an applicant for a buy to let mortgage product.
There are two factors to consider:
- The rental income
- The ability to repay the interest on the mortgage. This is referred to as the Interest Cover Ratio, referred to for short as ICR.
To give you an example of how a stress test works, consider the following hypothetical example:
A mortgage for a £150,000 property, assuming a 5.5% interest cover rate is applied brings the monthly interest payments on the BTL mortgage to £687.50 (150,000 x 5.5% = 8250 / 12 months = 687.50). When you factor in the notional rate for the assumed rental income of 125% for stress testing that brings the real monthly cost to £859.38.
In that situation, borrowing £150,000 to invest in a buy to let mortgage would require you to be able to rent the property at £859.38 PCM. Theoretically, you’d expect to rent anywhere above your interest payments of £687.50, but when the stress test is applied before you get your buy to let mortgage approved, this isn’t the case. That’s why it’s called a stress test. You must be able to prove you can afford the repayments.
The stress test applies to the total amount you’re borrowing and not the property price. If in the case of £150,000, you were to be applying with a 50% deposit, the stress test would apply to the £75,000 being borrowed.
The stress test uses an interest cover rate of 5.5% and a notional rate of 125% of rental income. That’s increasing to 145% and will need taken into account before applying for a buy to let mortgage.
Currently, this only applies to new buy to let mortgage applicants and not landlords looking to remortgage.
The Buy to Let Stress Calculations You Need
There are two things you need to know to begin calculating what you will be able to borrow.
The rate: Work with a minimum of 5.5% Interest Cover Ratio. That is the minimum you’ll need to account for.
Your rental margin: Use the higher rate of 145% because even if a lender is still using the 125% margin for your rental income, it will rise to 145%. It’s only a matter of time.
A Buy to Let Stress Test Calculator Differs from a Mortgage Stress Calculator
Do not mistake a mortgage stress test calculator – UK specific – to work out interest only payments on a buy to let mortgage
The type of mortgage you’re applying for affects how you’re tested against your suitability for any mortgage. The most basic mistake with buy to let mortgages would be to use an online mortgage calculator because those are based on income multiples and your ability to meet the affordability assessment criteria. That’s much different because it’s used for personal borrowing.
A buy to let mortgage is commercial in nature so it requires you to not only pass the affordability criteria for personal borrowing, but also the much more stringent stress test as well.
To do that, lenders differ in how they assess your ability to repay. Some will take into account your existing income, while other lenders will take into account the future rental income, while also factoring for dormant months when there are no tenants in the property. Some lenders will also assess your affordability for this type of mortgage product by taking into account your personal tax bracket as the income is taxable.
A personal mortgage stress test is only applicable to borrowing for your own home. Not for the purposes of buy to let. When you plan on leasing the property, buy to let mortgages will use the stress test, and that’s what’s changing at the moment.
Changes to the Buy to Let Stress Test 2017
Major lending institutions are rapidly rolling out their buy to let stress test changes throughout 2017. Both the Prudential Regulatory Authority (PRA) and the Financial Conduct Authority (FCA) have put their weight behind the consultation paper CP11/16, which some experts in the mortgage sector are describing more of a statement of intent. Ryan Bembridge, writing for mortgageintroducer.com states…
“…in the case of interest cover ratio and stress test changes which need to be implemented by the start of next year – the market norm is likely to be circa-5.5% at 145%”
Previous percentage figures for rent calculations were worked out at 125%, therefore, there is expected to be a 20% increase to rental income projections.
Mortgage Solutions UK report…
“This year we have already seen The Mortgage Works, Keystone Property Finance, Foundation Home Loans, Barclays and Newcastle Building Society upped their stress test calculations for individual borrowers to 145% at 5.5%.”
It’s worth pointing out that these changes are to be introduced to the buy to let lending sector as a phased implementation. As far as phasing it into the sector goes, it is being introduced rather quickly. Lenders have until the year-end to implement the changes, but it’s already clear that it’s being implemented faster, which indicates that many lenders are in agreement of these being worthwhile changes.
Online Rental Cover Calculator: Be Weary of the Figures
There are many calculators online on UK websites that let you work out how much rent you’ll need to charge to cover the interest only payments on a buy to let mortgage. A buy to let stress test 2017 calculator must use the 5.5% ICR and a notional rental income of 145%. If it doesn’t, your figures will be inaccurate and therefore won’t be satisfactory for the updated stress test requirements. For accurate results, use the formula further down to work out what you can realistically afford to borrow on a buy to let mortgage.
To ensure you have the worst-case scenario figures, use the Basic Higher Rate of 145% of rental income and the mortgage ICR of 5.5%.
The calculation formula to use is:
- “Buy to let mortgage price” x 5.5% = “annual interest rate” / 12 months = Your monthly interest repayments (ICR)
- Multiply the ICR coverage by 145% for the total you can borrow.
In practice, it would like this:
Buying a £100,000 property using a 50% deposit, you’d be borrowing £50,000.
£50,000 x 5.5% = £2,750 / 12 months = £229.17 interest only payments.
229.17 x 145% = £332.30.
You would need a minimum rental income of £332.30 to borrow £50,000 on a buy to let mortgage to meet the new stress test requirements coming into effect in 2017.
An online buy to let stress test calculator should use that same formula starting in 2017.
That’s not the only figures you need to account for though. There’s also the stamp duty for landlords, and the interest as there’s no longer interest relief for landlords using buy to let finance. For that reason, it’s worthwhile to consult with a financial advisor or your accountant when you’re looking to invest in properties with the goal being to produce income by renting the property.
Analysis of the Buy to Let Stress Test
This is a positive change to the lending industry as it ensures that in the event that tenancies are vacant, there are funds left to make the payments on time. In addition to that, there’s a higher cushion ensuring there’s enough rental income coming in to maintain the property.
Also note that those figures are likely to be used by main lenders. Figures could increase above the 5.5% ICR in cases where higher risk is involved due to adverse credit. When you’re using a specialist lender to access adverse credit buy to let mortgages, you’re best to go through a broker who has knowledge of the rates they expect your mortgage to be approved at. In most cases, rental cover calculators will not give you a realistic ball park figure to work from.
What the PRA and FCA are doing with these changes is raising the minimum. They are not placing caps with a maximum so only the mainstream lenders will be making their stress tests more stringent. The subprime market focuses on risk management because they lend to borrowers who have impaired credit. Many will already use a higher base line ICR because the rates and deposits are higher.
Buy to let stress calculators are best avoided when you have bad credit
With impaired credit, it’s unlikely that any online calculator will give you a real picture of what the figures are likely to be for you. They work out rates based on pre-set criteria and not your individual circumstances. Whilst the changes taking place will mean that the base line ICR is calculated at 5.5% for the mortgage interest, that’s likely to apply to landlords experienced and new with excellent credit reports. Any blemishes on your credit history will affect the real interest rate you’re charged.
It’s possible to get a mortgage with under the 5.5% interest, however, if you’re approaching lenders with a credit history showing CCJs, active DMPs, quite a few defaults and the likes, chances are you’ll be met with resistance, forced into the subprime market and the offers could exceed the 5.5% that’s considered a high rate for mainstream lenders. When put into practice from a subprime lenders perspective that can be average rather than high.
The only true way to understand how impeded your credit reports are making you to lenders offering buy to let mortgages is to get bespoke advice from a mortgage broker who understands lenders risks and the ICRs used by a variety of different lenders.
The 5.5% ICR and the 145% notional rate for rental income to cover the interest only payments leaving you with change to spare are only going to be the minimum to access any buy to let mortgage. There’s no upper cap, which makes it all the more critical to get expert advice based on your own personal circumstances before agreeing to a long-term secured loan.