What Is a Rental Stress Test?
The rental stress test checks if your rental income can cover your mortgage payments. It also includes a buffer for expenses, interest rate increases, and risks.
Lenders typically require rental income to exceed the mortgage interest payments by a specific percentage, known as the ICR. The required ICR varies depending on:
- Your tax bracket (basic, higher, or additional rate taxpayers).
- Whether you’re buying as an individual or through a limited company.
How Tax Brackets Impact Rental Calculations
Lenders adjust the rental stress test based on your personal tax bracket:
- Basic-Rate Taxpayers (20%)
- Lenders usually apply an ICR of 125% of the monthly mortgage interest.
- This means your rental income must be 25% higher than your interest payments.
- Higher-Rate Taxpayers (40%) and Additional-Rate Taxpayers (45%)
- A stricter ICR of 145%-160% is applied to account for increased tax liabilities.
- Limited Company Landlords
- Limited companies often benefit from a lower ICR, typically 125%-130%, regardless of personal tax brackets.
• This reflects the tax advantages of owning property through a company, where mortgage interest is fully deductible.
How Lenders Calculate the Maximum Loan
To calculate the maximum loan amount, lenders use the following formula:
Monthly Rent ÷ (ICR × Stress Rate) = Maximum Loan Amount
- ICR is the lender’s requirement based on your tax bracket or company status.
- Stress Rate is the assumed interest rate used to test affordability, typically 5.5%-7%, depending on the lender and mortgage product.
Example Calculations
For a Basic-Rate Taxpayer
Monthly Rent: £1,000
ICR: 125%
Stress Rate: 6%
Formula:
£1,000 ÷ (1.25 × 0.06) = £133,333
This means the maximum loan amount is £133,333.
For a Higher-Rate Taxpayer
Monthly Rent: £1,000
ICR: 145%
Stress Rate: 6%
Formula:
£1,000 ÷ (1.45 × 0.06) = £114,943
As you can see, higher-rate taxpayers qualify for a lower loan amount due to stricter ICR requirements.
Do Fees Affect the Maximum Loan?
Lenders often include all mortgage-related fees (e.g., arrangement fees) in the loan amount. However, not all lenders do this, so it’s essential to check whether fees are added to or excluded from the calculation.
Why Limited Companies Can Borrow More
Limited company landlords benefit from:
- A lower ICR requirement (typically 125%).
- Lower stress rates from some lenders.
This combination allows limited companies to borrow more against the same rental income than individual landlords.
How to Simplify Your Calculations
To quickly estimate your borrowing potential:
- Calculate your monthly rental income.
- Determine your ICR based on your tax bracket or company status.
- Use an online rental calculator or the formula above with the lender’s stress rate.
Key Points to Remember
- Tax Bracket Matters: Higher-rate taxpayers face stricter rental calculations, reducing the maximum loan amount.
- Limited Companies Have an Advantage: Lower ICRs and stress rates make borrowing easier.
- Fees May Be Included: Confirm whether fees are part of the loan calculation.
- Review Stress Rates: Different lenders use varying stress rates, so shop around for the best deal.
FAQs About BTL Mortgage Interest Rates
Do I need life insurance for a mortgage?
It’s highly recommended. Mortgage cover ensures repayments are covered if you pass away, so your family won’t face financial difficulties.
Can I get cover with medical conditions?
Yes, though premiums might be higher. Some insurers specialise in providing protection for people with health conditions.
How much cover do I need?
Your amount of cover should reflect your debts, living expenses, and future goals. Online calculators can help estimate this.
Is joint life cover cheaper?
Yes, but remember it pays out only once. Individual policies may offer more flexibility for some families.
Does life insurance cover rental properties?
Yes, many policies are designed to protect rental investments, ensuring they remain in your family’s portfolio.
Need Help? Let Us Guide You
At Compare the Mortgage, we specialise in helping landlords navigate rental calculations and secure the best buy-to-let mortgage deals. Here’s how we can assist:
Expert Advice
Tailored recommendations based on your tax bracket, property type, and rental income.
Comprehensive Support
From stress rate explanations to lender comparisons.
Access to Specialist Lenders
Explore options for limited companies and higher-rate taxpayers.
Secure Your Ideal BTL Mortgage Today
Contact us today to optimise your borrowing potential and secure the perfect buy-to-let mortgage.