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Buy to let mortgage affordability

A look through how much someone can borrow for a buy to let mortgage

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By Pete Mugleston   Mortgage Advisor

Last updated: 8th February 2019 *

Can I afford a buy to let mortgage?

We receive lots of enquiries asking about buy to let mortgages and affordability from people looking to establish whether or not they can borrow the amount they require.

As a result of the changes introduced from 2016 by the UK Government and the new guidelines from the Prudential Regulation Authority (PRA) in 2017, you may have found it more difficult to ascertain the required amount of borrowing for a buy to let mortgage. The good news is there are lots of options still available for you.

Once you’ve read through the information below, make an enquiry with us and we will arrange for a buy to let specialist to contact you direct and discuss your own circumstances in more detail.

In this article we will cover:

  • How do buy-to-let mortgages work?
  • In what way could the regulatory changes introduced in 2017 affect a buy to let application?
  • How much can I borrow on a buy-to-let mortgage?
  • What is the typical debt to income ratio for an investment property?
  • What other aspects of affordability do lenders consider for a buy to let mortgage?
  • Who is eligible for a buy to let mortgage?
  • What other costs are associated with a buy to let mortgage?

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How do buy-to-let mortgages work?

If you’re planning to purchase a property for investment purposes rather than to live in, you cannot fund this purchase using a typical, residential mortgage. You need to use a buy to let mortgage.

A larger deposit is usually required for a buy to let mortgage and you may need to pay a higher rate of interest on your repayments. It’s also fairly common for buy to let landlords to incur higher costs both at the outset and during the term of the mortgage.

Traditionally, buy to let mortgages are only offered on an interest-only basis whereby the original amount you borrow, rather than reduce gradually during the term, is repaid in full at the end. Your monthly repayments are usually lower as you are only paying the interest element rather than both capital and interest with a repayment mortgage.

However, whilst most lenders offer buy to let mortgages as interest only, nowadays there are some lenders who will also offer capital and interest buy to let mortgages and a few who will offer a combination of both types of lending.

Rather than relying on disposable earned income to cover repayments, like with residential mortgages, a prospective buy to let landlord will use the rental income they receive from the investment property to cover the monthly payments for their buy to let mortgage.

This is the main reason why buy to let mortgages can be viewed as high risk by lenders as there may be some months during the term where rental income is not received or the property has no sitting tenants for an unknown period of time. This risk, therefore, prompts the need for higher deposits and costs applied by lenders.

If you’d like to know more about how buy to let mortgages work have a look at our detailed guide.

In what way could the tax and regulatory changes recently introduced affect a buy to let application?

The recent tax and regulatory changes introduced in both 2016 and 2017 have had a fairly significant effect on the buy to let property market, which, up to that point, had begun to grow quite rapidly.

There were two main tax changes introduced by the UK government, beginning in April 2016, as follows:

Stamp duty increase

An increase of 3% stamp duty was imposed on all investment properties and second homes in an attempt to cool down the buy to let market, making it less lucrative for any short-term buying and selling strategies.

As an example, if you bought a house for £300,000 as your main residence you would be required to pay £5,000 in stamp duty. If you bought the same property for the purpose of a buy to let investment you would have to pay £14,000 stamp duty, representing a £9,000 increase.

Halting all income tax relief for mortgage interest on buy to let

Up until the current tax year (2017/18) landlords have been able to deduct their mortgage interest payments as an allowable expense from their gross rental income for income tax purposes.

The government has now begun to completely phase out this tax benefit for landlords from now until the 2020/21 tax year.

Previously, if you had gross rental income in a year of £12,000 and mortgage interest of £6,000 you would simply declare the net difference of the two amounts (£6,000) whereas by the end of the 2020/21 tax year the gross rent figure is what must be declared.

These tax changes will have a big impact on determining whether someone enters the buy to let market. In particular, the change to income tax relief for mortgage interest could now place landlords who were previously just under the lower income tax threshold over the higher rate threshold, therefore, increasing their overall tax liability.

What can I do?

If you’re concerned at all about how this may affect you, make an enquiry with us and we can ask for an advisor we work with to speak with you directly.

Prudential Regulation Authority (PRA) changes

As a result of the new tax reforms introduced by the government, the Prudential Regulation Authority (PRA) introduced new regulations in 2017. There were three main changes affecting buy to let mortgage affordability criteria:

  • Stricter affordability checks using a higher ‘stress rate’
  • Full review of an applicant’s tax position as part of an affordability assessment
  • More stringent underwriting for landlords with four or more buy to let properties within their portfolio

The impact upon affordability checks for buy to let mortgages will be reviewed in more detail in the sections below.

How much can I borrow on a buy-to-let mortgage?

The traditional thought process for buy to let mortgages was that they are totally self-funding. Your rental income more than covers your mortgage payments with a little profit left over.

However, the reality is that rental payments can vary depending on location and may suddenly stop for any number of reasons. This, along with a need to ‘cool’ the market and respond to the recent tax changes are why the PRA stepped in.

The maximum you can borrow for a buy to let mortgage is still directly linked to the amount of rental income you anticipate receiving or that you feel is appropriate for the property you wish to buy.

However, the recent changes outlined above have ensured that lenders must carry out more stringent affordability assessments, specific to buy to let mortgages, in order to safeguard both themselves and the applicant.

What is the typical debt to income ratio for an investment property?

Each lender will have their own affordability criteria which governs how much they are prepared to lend. Up until January 2017, most lenders would want to see rental income achieve a minimum 125% of interest payments.

This extra amount over the interest payments is what is known as the ‘stress rate’ or Interest Coverage Ratio (ICR) and was originally designed to ensure a borrower had a safe buffer of spare income in the event of any cessation in rent payments.

Prior to 2017 lenders were able to relax their stress rates if they wished (typically to attract more custom).

The new PRA regulations dictate a minimum stress rate of 125% tied to an interest rate of 5.5% must apply, which most lenders now use. However, some lenders use a higher rate of up to 145% and a few go up to 160% in order to cater for high-rate taxpayers.

Buy to let mortgage calculator - how much can I borrow?

If you’re a prospective buy to let landlord and want to work out what is the minimum rent you would need to receive in order to satisfy a lender’s affordability criteria, take a look at the example below, using a mortgage amount of £150,000:

£150,000 x 5.5% = £8,250/ 12 (months) = £687.50 x 125% = £859.38 (Rental income required)

If we use the same mortgage example but a higher ICR of 160%:

£150,000 x 5.5% = £8,250/ 12 (months) = £687.50 x 160% = £1,100 (Rental income required)

As you can see, the stress rates will push up the amount of rent you need to bring in from your property. Other factors will then come into play, such as location, in determining whether this is feasible.

This is where we can help as you need to find an advisor who understands the buy to let market and can assist in finding you the right lender who can cater for your needs. If you make an enquiry we will put you in touch with a specialist in this area.

What other aspects of affordability do lenders consider for a buy to let mortgage?

In addition to stress testing the rental income/mortgage payment ratio, there are some other areas that a lender may wish to explore. For example, most lenders will generally disregard applications where the applicant’s income is less than £25,000.

Income and buy to let portfolio size can be key factors in determining how much a lender feels an applicant is able to afford, as outlined here:

High-rate taxpayers

Due to the guideline changes introduced by the Prudential Regulation Authority (PRA), high-rate taxpayers face more scrutiny when applying for a buy to let mortgage than low rate taxpayers.

This is due to the changes to the mortgage interest tax relief which places a higher tax burden onto people who fall into this category. Every lender will approach this differently and use their own calculations.

However, it’s likely that the stress rate used for high-rate taxpayers will be higher than the one used for low rate taxpayers, meaning low rate taxpayers may well be able to borrow more.

If you’re a high-rate taxpayer and concerned about these changes, we work alongside a number of buy to let specialists who may be able to help. If you get in touch we can arrange for someone to speak with you directly.

Large portfolios

A lender will consider a large, already heavily mortgaged, portfolio more high risk when considering further lending than a smaller one. Changes made by the PRA have made it clear to lenders that portfolios with four or more properties should receive much closer scrutiny when considering further lending.

Rather than showing an overall profit and loss figure across the portfolio as a whole a portfolio landlord may be asked for the Interest Coverage Ratio (ICR) position across each property they own separately.

Some lenders may also place a maximum number of properties where they are prepared to consider further lending (eight, for example) or a maximum loan to value.

Income top-slicing

If a lender is concerned about the ICR of a buy to let application, some are prepared to take into account your earned income as part of a top-slicing exercise. If you have a strong income from your employment you can use this income to bridge the gap between an ICR shortfall.

Who is eligible for a buy to let mortgage?

All lenders use their own criteria for both affordability and eligibility for buy to let mortgages. If you’re venturing into this market for the first time it can appear quite confusing.

Some lenders require all applicants to be resident in the UK and some will specialise in mortgages for expatriates, for example. Some lenders will not consider applicants with a poor credit record and some will.

Thankfully, we’ve been able to put together an article which looks, in detail, at all the different aspects of buy to let eligibility.

What other costs are associated with a buy to let mortgage?

In addition to the costs associated with setting up a buy to let mortgage and the tax implications as outlined above, there are other fees that a prospective landlord needs to factor into their budget, such as:

  • Landlord’s insurance
  • Rent Insurance
  • Liability insurance
  • Maintenance costs
  • Letting agent’s fees

Why you should speak to an expert buy to let mortgage broker

At Online Mortgage Advisor we can offer you a first-class service tailored to your own specific needs with access to the most experienced brokers available that:

  • Have whole of market access
  • Have excellent relationships with lenders
  • Are OMA accredited advisors
  • Have completed a 12 module LIBF accredited training course

Speak to a buy to let mortgage expert

If you have questions and want to speak to an expert for the right advice, call Online Mortgage Advisor today on 0800 304 7880 or make an enquiry here.

Then sit back and let us do all the hard work in finding the broker with the right expertise for your circumstances.  – We don’t charge a fee and there’s absolutely no obligation or marks on your credit rating.

Updated: 8th February 2019
OnlineMortgageAdvisor 2019 ©

FCA disclaimer

*Based on our research, the content contained in this article is accurate as of most recent time of writing. Lender criteria and policies change regularly so speak to one of the advisors we work with to confirm the most accurate up to date information.

The info on the site is not tailored advice to each individual reader, and as such does not constitute financial advice. All advisors working with us are fully qualified to provide mortgage advice and work only for firms who are authorised and regulated by the Financial Conduct Authority. They will offer any advice specific to you and your needs.

Some types of buy to let mortgages are not regulated by the FCA.

Think carefully before securing other debts against your home. As a mortgage is secured against your home, it may be repossessed if you do not keep up with repayments on your mortgage. Equity released from your home will also be secured against it.