This information should not be interpreted as financial, tax or legal advice. Mortgage and loan rates are subject to change.
Summary of the case
- Buy to let mortgage was up for renewal
- Joint applicants wished to raise capital to pay off credit cards
- Rent would not support borrowing required
What we achieved for the client
- Used top-slicing to raise the required funds
- Locked in a five year fixed rate the day before it was being withdrawn
- Achieved a mortgage offer within 8 days of submission
- Buy to let mortgage with top-slicing scenario
- Why are buy to let mortgage affordability calculations changing?
- How is buy to let mortgage affordability calculated?
- What is a buy to let mortgage interest coverage ratio (ICR)?
- What are the options when you fail buy to let mortgage affordability calculations?
- What is top-slicing on a buy to let mortgage?
- How does top-slicing differ when on a fixed rate versus tracker rate buy to let mortgage?
- Using top-slicing to overcome tightening buy to let affordability calculations
We contacted a client in the run up to their buy to let mortgage renewal date, to help them find a new deal. It is important to understand, from clients in this position, if their needs have changed. In the case of this client they had.
The client was looking to pay off outstanding credit cards and wanted to raise capital (i.e. increase their existing borrowing on their mortgage) to do so.
Whilst this increases the overall amount owed on the mortgage, some clients opt to do this because the interest rate charged on longer-term borrowing can be lower than they would be charged via another form of borrowing – in this case, credit cards.
Think carefully before securing other debts against your property. Your property may be repossessed if you do not keep up repayments on your mortgage. By consolidating your debts into a mortgage you may be required to pay more over the entire term than you would with your existing debt.
Prior to the recent changes in buy to let mortgage underwriting, we could have easily raised the funds the client was looking for.
Buy to let mortgage interest rates have been increasing, as a result of the Bank of England Base Rate being increased, to combat the rise in inflation in the UK.
When mortgage rates increase, mortgage affordability calculations have to reflect the increase. This means that lender ‘stress rates’, used to determine if a mortgage deal is affordable, have recently become a lot higher than they were in the past.
The higher the ‘stress rate’, the more the rent has to be, to exceed the mortgage payment amount by enough to meet ‘rental coverage’ requirements (more information below).
When lenders calculate whether a mortgage is affordable to a borrower, they are required to establish that the deal is affordable not just using the current scenario, but also if mortgage costs went up.
This is done to help protect the borrower from rising mortgage interest rates and circumstances where rent is not paid by the tenant (which is the route to paying the mortgage).
To establish if a buy to let mortgage is affordable to a borrower, a calculation called the Interest Coverage Ratio (ICR) is used. The ICR calculation uses two factors.
Rental coverage: A lender will require the rent to cover the mortgage payment by more than 100%, typically by 125% or 145%, depending on the income tax bracket you fall into. This is referred to as rental coverage.
So, if the mortgage was £800 per month, the rent would need to be at least £1,000 at 125% rental coverage, or £1160 at 145% rental coverage, to ‘fit’ the rental coverage element of the mortgage affordability calculation.
Stress rate: Lenders also apply a “Stress rate” to the calculation. This is where a lender will use an interest rate that is higher than the actual mortgage interest rate of the deal, in the ICR calculation.
The rental income must still exceed the mortgage payment amount by the rental coverage amount when calculated using the stress rate, in order to be accepted as affordable to the borrower.
If the rent you receive from your property is too low to pass affordability calculations for a standard remortgage, there are two options available which may enable you to borrow the amount you require.
You can approach your existing lender and see if they will increase the borrowing you have with them, this typically saves on legal fees.
Usually though, a search of the wider mortgage market will offer more opportunities including criteria such as Top Slicing or affordability based lending, which is based on using your disposable household income to top up rental coverage. This can be especially helpful in overcoming tight mortgage affordability calculations (more on this below).
When we ran the amount our client was looking to raise through our buy to let mortgage affordability calculator, we established that on a straight remortgage, we could only raise half the amount the client required.
We assessed alternative options and looked at two possible routes to raise the funds.
First, we investigated a further advance on the buy to let mortgage already secured on the property, with the client’s existing lender.
Second, we investigated a remortgage with another lender using top-slicing.
Top-slicing describes a situation where a borrower uses their excess personal income, to support a mortgage affordability calculation.
When you use top-slicing, you are essentially saying that where the rent only meets 100% of the mortgage payment amount, if the mortgage were to become more expensive, you would use your personal income to cover the extra cost.
Not all lenders offer top-slicing, but where they do, this can help borrowers overcome tighter mortgage affordability calculations.
It is very important to realise that this would impact your personal finances, if you were put in the position where you had to make up an additional amount owed on a mortgage payment, if the rent fell short.
There is a slight difference in the risks associated with top-slicing, depending on the rate type you use it with.
Top-slicing with a buy to let fixed rate mortgage: If you use top-slicing on a buy to let mortgage with a fixed rate, changes in mortgage interest rates during your initial rate period won’t affect you.
So, rising mortgage interest rates wouldn’t put you at risk of having to top up your mortgage payment with your personal income (your mortgage rate won’t change during the initial mortgage rate period of a fixed deal).
The risk of your having to top up would come from any periods where you had no tenant, or if your tenant stopped paying the rent on time or in full.
Top-slicing with a buy to let tracker or variable rate mortgage: If you use top-slicing on a buy to let mortgage with a variable or tracker rate, then changes in mortgage interest rates during your initial rate period could result in your monthly payments going up.
This is a scenario where you may end up using personal income to help meet monthly mortgage payments.
As with fixed rate deals, voids and non-payment, or late payment of rent also puts you at risk of having to top up your mortgage payment.
We found that the mortgage interest rate we could achieve from a further advance with the client’s existing lender was not as favourable as a remortgage with another lender, using top-slicing to support the buy to let affordability calculation.
We were working with the client in the midst of a flurry of changes from buy to let mortgage lenders, who were reacting to the rising Bank of England Base rate.
The deal we identified had to be secured quickly, as we had had notification from the lender that it was being withdrawn.
Working closely with the client, we managed to submit the deal the day before it was being withdrawn. This secured a favourable 5 year fixed rate buy to let remortgage in the nick of time.
What’s more, it only took 9 days to get the mortgage offer, guaranteeing the client they could secure the required capital raising they needed to pay off their credit card bill.