Consultant Mortgage Broker, Adam Henderson, explains how mortgage lenders assess borrower affordability when purchasing or remortgaging buy to let investment property.
How is buy to let mortgage affordability calculated?
Unlike your home mortgage, which is based solely on your income, buy to let mortgages are primarily determined by the property’s potential rental income.
Loan to Value (LTV)
When it comes down to it, LTV strongly dictates how much you can borrow for a buy to let mortgage.
LTV is the difference between the loan amount and the value of the property, expressed as a percentage; currently, the maximum LTV for buy to let mortgages is 85%, meaning borrowers require a deposit of 15% of the value of the property (but interest rate pricing is high here). Generally, 75% LTV is considered the sweet spot for pricing for buy to let mortgages, although the cheapest rates tend to sit around 60% LTV. Anything below 60% LTV, and the pricing doesn’t change a considerable amount.
Buy to let rental stress tests
Lenders use rental stress tests to calculate whether the rental income generated by the property is enough to service the mortgage. These calculations can vary depending on the lender, the product, the borrower’s tax bracket and how you invest (personally or as a limited company). Here’s an example:
A property generates £700 per month in rental income (£8,400 per annum)
Individual applications are typically stress tested at 145% @ 4.5%.
£8,400 divided by 4.5%, divided by 145% = £128,735 maximum loan.
Limited Company applicants are typically stress tested at 125% @ 4.5%.
£8,400 divided by 4.5%, divided by 125% = £149,333 maximum loan.
The calculations differ for individuals vs limited companies because of the different ways these two structures pay tax. Limited companies pay corporation tax at 19%, whereas a basic-rate taxpayer will pay 20% income tax (and higher-rate taxpayers 40%). Therefore, most lenders believe that personal investors will likely pay more tax, thus requiring the higher 145% rental calculation.
As I said above, these calculations vary, meaning you may be able to borrow more with another lender. Having an experienced mortgage broker on-side to help with these comparisons will always be a big help in getting you the right product! You must also speak to a professional tax advisor about the most suitable way to invest, as everyone’s circumstances vary.
Top Slicing
If the rental value of a property doesn’t quite meet the stress test calculations required for the amount you need to borrow, some lenders will allow you to use some of your income to “top up” and meet the required amount. Usually, the lender needs to be comfortable that the income used is surplus and comes from somewhere other than property to minimise risk.
So, when working out whether you can afford to purchase a buy to let property, these are the rough steps you need to take:
How much deposit do you have? Depending on the LTV you’re after, this will dictate your maximum purchase price.
How much rental income will the property yield? Using the rental stress test calculations above as a rough guide, will this satisfy how much you need to borrow?
Minimum and maximum buy to let mortgage loans sizes
Typically, the minimum loan size for the majority of buy to let mortgage lenders is around £25,000, dictated by a minimum property value of £50,000. However, as with many criteria elements of mortgage lenders, this varies considerably.
Within the buy to let lender market, there is no defined maximum loan amount. Essentially, a property’s rental income, value and the loan to value required dictate the maximum loan available. Usually, it’s other criteria that may push you out of buy to let lender territory; for example, if you’re purchasing a £5 million multi-unit block with more than 20 units, then you’re likely to move into commercial mortgage territory. The reason is that no buy to let lenders accept more than 20 units on a MUFB rather than the purchase value.
Portfolio Landlords
A portfolio landlord is defined as anyone who owns four or more mortgaged buy to let properties. Not all lenders are comfortable lending to portfolio landlords, and some have specific buy to let mortgage ranges.
Mortgage affordability for portfolio landlord applications is calculated in different ways depending on the lender. Some will assess the whole background portfolio, considering all debts, rents and values, whereas others only assess those properties mortgaged with them. They will use similar rent stress calculations to the ones shown above.
As buy to let lender criteria get more complicated for portfolio landlords, it’s definitely worth talking to a good mortgage broker (like us!) to guide you to the suitable lenders and products.
Find your next buy to let mortgage
If you have any questions about buy to let mortgage affordability or want to discuss your buy to let investment plans, do give me a call on 01732 471658, or email me, adamh@mfbrokers.co.uk, and I’ll be happy to help!
Find out how much you could borrow and search all the latest buy to let mortgage rates using our helpful mortgage calculators.
