How Do Mortgage Lender Affordability Calculations Work?

Read this blog for a comprehensive explanation of what rent to interest calculations are, why lenders use them and what can impact buy to let mortgage affordability.

Finding a buy to let mortgage rate can be complicated; you need to consider the interest rate, lender criteria, loan to value (LTV), among many other things. You may think you’ve found the perfect mortgage for your investment property, only to have a lender come back and say, “the affordability doesn’t work”. “But the rent covers the monthly repayments!?” I hear you cry. But does it satisfy the Rent to Interest Calculation (RTI)?

What is a Rent to Interest Calculation? 
RTIs have many names: stress test, rental calculation, debt service cover ratio (DSCR), but they all mean the same thing. 

Mortgage lenders expect buy to let properties to be self-financing, meaning that the property should pay for itself and not require you (the landlord) to contribute to its upkeep of cost of financing it from your own income. Unlike financing your own home, where affordability is based on your earnings, buy to let mortgage affordability relies on the rental income. Therefore, to ensure a property is self-financing, lenders use RTI calculations to ensure that the rent is sufficient to cover the debt, plus any additional maintenance costs.

The way the lenders express their calculation would be that the rent needs to be, for example, 125% assuming an interest rate of 4%. So, if you wanted to borrow £200,000:

£200,000 x 4% = £8,000
£8,000 x 125% = £10,000

Therefore, the rent needs to be £10,000 per year.

Why do buy to let lenders use rental affordability calculations?
Lenders require a surplus each month between receiving the rent and then paying the mortgage interest (profit, if you will). This surplus gives you, the borrower, some headroom to accumulate saving to cover costs such as repairs, maintenance, tax, and rental voids.

What impacts BTL mortgage rental affordability?
As with many aspects of mortgage criteria, RTI varies from lender to lender and product to product. Here are the main elements that will impact your RTI rate:

  • The length of a fixed rate (i.e., two or five years fixed)
  • How you own the property (in your personal name or a limited company)
  • If owned personally, whether you’re a basic or higher rate taxpayer
  • The type of property (standard house, HMO or multi-unit)
  • The interest rate you’re taking
  • If remortgaging, is it like-for-like (i.e., you’re not increasing the mortgage balance)
  • The lenders own approach to the calculation

 

Why are stress tests on five-year fixed products more generous?
As a consequence of the 2008 financial crash, the Financial Policy Committee (FPC) made several regulation changes around mortgages to protect borrowers from taking on too much debt. One of those changes included affordability tests; however, the same rules do not apply to fixed rates of five years or more. 

Five-year fixed rates are still stress tested to ensure the mortgage is affordable, but you’re likely to get a more generous calculation if you fix for five years. How this impacts your property investment plans is something to talk to your broker about to see what options are best for you.

Personal or limited company ownership?
The way you own your BTL property dictates your tax position. A lender will assume you’ve taken professional tax advice and use the most tax-efficient ownership structure for your circumstances. As limited companies pay corporation tax rather than income tax, they are taxed at a lower rate, especially if you’re a higher rate taxpayer (earning £50,000+ per annum). Lenders assume that limited companies will probably have smaller tax bills than personal investors (again, I need to stress that individual circumstances very much determine this, and you should seek professional tax advice before making investment structure decisions). Therefore, limited company mortgages usually have more generous stress testing compared to personal BTL mortgages.

Basic or higher rate taxpayers
The logic behind this is relatively similar to the above. Lenders anticipate that higher rate taxpayers will pay more tax than basic rate taxpayers. Therefore, higher rate taxpayers will need a more generous calculation to achieve the borrowing level required. The best way to ensure you’re getting the most suitable BTL mortgage is to speak to a qualified mortgage broker who will be able to calculate all this for you.

Top-slicing
So, we know that buy to let mortgage affordability is based on the property’s rental income. However, some lenders offer top-slicing to make the affordability work in certain circumstances. 

If the predicted rent for your property wasn’t quite enough to meet the RTI calculation, some lenders will take into account a portion of your own income to bridge the gap. Generally, this option is only available to borrowers with a substantial and steady income stream.

HMOs and Multi-Unit Freehold Blocks (MUFB)
Typically considered more complex buy to let investment properties, HMOs and MUFBs tend to attract more stringent RTI calculations. While these can be incredibly high yielding investments, it’s expected that these types of properties will attract higher maintenance costs and mortgage interest rates.

As a general rule, the rental calculation is most stringent on a higher rate taxpayer, owning a property personally, borrowing on a non-five-year fixed rate. The most generous calculation would be for a limited company, borrowing on a five-year fixed rate. However, as these calculations are complex and vary hugely across the market, your best option is to use our mortgage calculator, which does the maths for you or speak to one of our expert team about your options. Call 0345 345 6788 or email enquiry@mortgagesforbusiness.co.uk today!

NB: ANY PROPERTY USED AS SECURITY, WHICH MAY INCLUDE YOUR HOME, MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE

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