I have been looking into buy-to-let mortgages. I understand lenders want at least 125% rental yield, which I believe means the rent paid by the tenant must be 25% above the mortgage repayment of the landlord. However, I have also seen ‘interest coverage ratio’, for example, Mortgage Trust and Paragon Mortgages have increased their interest coverage ratio to 5.35%. Could you explain what this means and how does it fit in with rental yield?
All buy to let lenders require that the rental income covers the mortgage payment plus a margin to cover other costs. The calculation used varies from lender to lender and even from product to product. Until recently the general rule of thumb was that the rent needed to cover the mortgage payment by 125% assuming a notional interest rate of circa 5%, i.e. 125% @ 5%, regardless of the actual rate you pay.
However, increasing costs for landlords who borrow personally (such as the restrictions on interest relief) have led a few lenders to increase the interest cover ratio (ICR) or rent to interest (RTI) calculation as it is also known.
Going forwards it is likely that other lenders will follow suit. Do note that some lenders will offer more favourable RTI calculations to landlords borrowing through limited companies because they will not be affected by the proposed restrictions on mortgage interest relief.