With this knowledge, property investors will get the best investment financing
Whether you’re a first-time investor or experienced in buy-to-let property, it’s worth understanding how lenders assess for buy-to-let mortgages.
Assessing your income for buy-to-let property investment
When you apply for a residential mortgage to buy your own home, the lender will assess your income and ability to pay the mortgage payments. They will take into consideration income from employment, pensions, and benefits.
Buy-to-let mortgage lenders look at income differently. They look at rental income and they want it to cover mortgage interest payments and more. Typically, a lender wants a rental income of 125% of the mortgage payments. Some lenders ask for the cover of 140%. This is called the Interest Coverage Ratio (IC). This means that if your mortgage interest payments are £800, your rental income must be assessed at between £1,000 and £1,120. This rental income potential must be confirmed by a surveyor.
Why does the lender want such a high ICR?
When lending on a buy-to-let property, a lender takes on more risk than when lending to a homebuyer. They consider the possibility (though slim) of you getting a rogue tenant who stops paying their rent. They also need to make sure that the rent collected previously will cover interest payments during void periods when you don’t have rental income. They cover these risks by assessing in ICR as outlined above.
Stress testing interest rates
The PRA also introduced a stress test for buy-to-let mortgages. Lenders must make sure that you will still be able to afford the interest payments if the mortgage rate rises. They do this by calculating the ICR not on the actual interest you pay, but on a theoretical rate of 5.5% or 1% above the actual rate, whichever is the higher.
In other words, if the mortgage interest payment of £800 per month is based upon a mortgage interest rate of 4%, the ICR required will be based on an interest rate of 5.5%. If rates increased to 5.5%, the mortgage interest payments would be £1,100. At an ICR of 125%, rental income would need to be £1,375.
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However, all is not lost.
You might be able to include your personal income
Some lenders will allow you to include personal income when assessing the affordability of a buy-to-let mortgage. This is essential if you are investing in a property that has a negative cash flow. Don’t be put off by a negative cash flow property – many properties start off this way, and often a property with negative cash flow offers better potential capital gain.
A word of warning if you intend to use your personal income as part of the affordability assessment for buy-to-let: doing so may affect your ability to get a mortgage to buy a home, or to remortgage your current home if you need to.
Some lenders might assess for buy-to-let costs
Some lenders may also want to know that you can afford the costs of running a buy-to-let property. These costs include:
- Property management fees
- Maintenance costs
- Landlord insurance
How do you get the best buy-to-let mortgage deal?
The buy-to-let mortgage market is very competitive, with thousands of products available. However, it is also niche. Many of the best buy-to-let mortgage deals are offered by specialist lenders.
Using a buy-to-let mortgage broker will help you find the best financing for your buy-to-let strategy and personal financial circumstances. They’ll have access to the whole market, will be on top of any rule changes, and know how strict each lender’s assessment criteria is.
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