When considering a buy-to-let mortgage, along with requirements and criteria, it's important to understand the key metrics that lenders use to determine whether or not to lend to you. This will help you understand if you are eligible for a buy-to-let mortgage and if you match up with the criteria required. These key metrics include the interest coverage ratio (ICR) and loan-to-value (LTV) ratio, using these metrics you can understand whether you can afford your mortgage.
The LTV ratio is the amount of the mortgage loan compared to the value of the property. The ICR, on the other hand, is used to assess the ability of the rental income to cover the mortgage payments.
The ICR is typically 145% when applying for personal ownership mortgages, which means that the rental income must be at least 145% of the mortgage payment, as lenders take into account that the investor will have to pay income tax on the rent when buying in a personal name. In limited company mortgages, lenders typically require an ICR of 125% or more. The implication behind this number is that lenders will reduce the amount of borrowing they are willing to offer if the ICR stress test does not meet their requirements, meaning the investor will often require a larger deposit.
Suppose you're looking to buy a £200,000 property that generates £1,000 per month in rental income. You're applying for a mortgage with a 125% interest coverage ratio, a 70% LTV, and a 6% interest rate.
To calculate the maximum mortgage amount you could borrow, you would start by calculating the property's maximum affordable interest payment. This is done by multiplying the rental income by the interest coverage ratio (125%) and then dividing by 12 months, which gives you £1,042.
Next, you would calculate the maximum mortgage amount by multiplying the property value by the LTV ratio (70%), which gives you £140,000. In this example, the maximum affordable mortgage payment (£1,042) is higher than the mortgage payment required for a £140,000 mortgage at 6% interest (£840), which means that you could afford this mortgage.
Finally, when getting a buy-to-let mortgage, investors will also have to take into consideration several fees. These fees include arrangement fees, valuation fees, legal fees, and broker fees.
Let's take a £150,000 mortgage as an example. Assuming a 2% arrangement fee, a £750 mortgage broker fee, a £250 valuation fee, and a £1,500 legal fee, the total fees would be £5,500. This comes to a total of £5,500 that the investor will have to pay on top of other costs such as stamp duty and solicitor fees.
Let us do the hard work for you. Our buy-to-let mortgage calculator will help you run the numbers, making it easier to understand how much you can borrow. With GG Mortgage we can even set you up with a lender.