Test one: loan to value
Loan to value is the mortgage as a percentage of the property's value. Most buy to let lenders go up to 75%, some to 80%, and the best rates are usually at 60% or 65%. On a £250,000 property, 75% is a loan of £187,500 and a deposit of £62,500.
The value is the lender's surveyor's valuation, not the price you agreed. If the valuation is lower than the price, the loan is based on the lower figure.
Test two: rental cover
Rental cover, also called the interest cover ratio or ICR, checks that the rent comfortably covers the mortgage interest even if rates rise. The lender takes the monthly rent, divides by a test rate and by the cover it requires, and that gives the maximum loan.
For example, with rent of £1,250 a month, a test rate of 5.5% and cover of 125%: £15,000 a year divided by 0.055 divided by 1.25 is £218,182. With cover of 145% the same rent supports only £188,088.
Why there are two cover levels
Individual landlords who pay higher or additional rate tax cannot deduct their mortgage interest; they get a 20% credit instead, so their after-tax position is weaker. Lenders allow for that by asking for more rent behind each pound borrowed, commonly 145%. Basic rate taxpayers and limited companies are often tested at 125%.
The test rate is set by each lender. It is often higher than the rate you will actually pay, but many lenders test five year fixed rates at the pay rate instead, which can raise the loan considerably. This is one of the main reasons landlords choose five year fixes.
When the rent decides the loan
In higher value areas the rent is often low relative to the price, so the rental cover test produces a smaller loan than 75% of the value. The deposit then has to be bigger than 25%. The borrowing calculator shows which test is limiting you and what rent you would need for the full loan to value.
Other things lenders look at
- Your own income. Many lenders set a minimum personal income, and some will top up a rental cover shortfall from it, often called top slicing.
- Your experience. Some lenders will not lend to first-time landlords, or require you to own your own home.
- The property. Flats above shops, ex-local authority blocks, non-standard construction and short leases can narrow the choice of lenders.
- Your portfolio. With four or more mortgaged buy to let properties you are treated as a portfolio landlord, and lenders look at the whole portfolio, usually with a business plan and cash flow figures.
- Company or personal. Limited company mortgages are widely available but often carry slightly higher rates and fees, and lenders usually want personal guarantees from the directors.
At renewal
Switching to a new product with your existing lender, without borrowing more, usually avoids a fresh affordability test. Moving to a new lender or raising more money means passing the tests again at the rates and criteria of the day. The remortgage stress test checks whether your rent still supports the loan you have.