Stress tests: Why you can borrow more via a Ltd Co

Borrowing personally or via a limited company – up until recently it wouldn’t have made much of a difference when it came to lenders’ stress tests but this is all changing. Gary McKenna explains how much you will be able to borrow going forward.

Buy to let lenders have used roughly the same c.125% @ 5% rental stress test for years to determine the maximum borrowing available to individuals and limited companies. The formula behind it is that the rent should cover 125% of the mortgage if the mortgage is paid at an interest rate of 5%.

To determine how much you could borrow you take the annual rental figure, divide it by 5% then divide the answer by 125%.

Example 1:

125% @ 5%
Annual rental income: £12,000 / 5% = £240k / 125% = £192,000 (max loan amount)

Earlier this year, the Prudential Regulation Authority (one of the regulatory bodies) published a consultation paper which proposed that, going forward, interest rate affordability stress tests should be tightened. This means that in future stress test calculations will get tougher for personal borrowers which in turn, means that the amount they will be able to borrow will be reduced.

As a result of these proposals, lenders have started to increase the rental cover from c.125% at 5% to 145% at 5.5% (sometimes more) for personal borrowers. To understand how this works in practice, here is how the example given above changes using the new stress test:

Example 2:

145% @ 5.5%
Annual rental income: £12,000 / 5.5% = £218,182 / 145% = £150,470 (max loan amount)

This means that the amount that can be borrowed by individuals decreases by a massive £41,530.

The rationale behind the new calculation is that landlords borrowing personally are likely to pay more tax than previously due to the changes to mortgage interest relief, so lenders have to tighten up their exposure to ensure responsible lending.

Limited companies however are not impacted by the mortgage interest relief change and as such lenders can keep the 125% rental calculation.

Current borrowing options for individual landlords at 125%
For now there are still options out there for those of you looking to borrow personally at 125%, however these options are becoming fewer and further between. We have already seen numerous lenders up their stress tests for individuals including The Mortgage Works, Keystone Property Finance, Woolwich and Coventry and the rest are set to follow.

My prediction is that all buy to let lenders will have increased their stress tests for individual applicants by the end of the year.

For further information do give me a call on my direct dial 01732 471652 and I will be happy to discuss. 

You may also be interested in:

Why are buy to let mortgage stress tests getting tougher?

What is a stress test and why do lenders use them?

How the restriction of relief on BTL mortgage interest will affect landlords

Lock into a rate with a low RTI now and complete in 2017

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