12:26 PM, 12th November 2010, About 11 years ago
By Neil Patterson, Partner of The Money Centre.
Most mortgage lenders use credit scoring to determine whether an applicant is “good for credit”. However, unlike personal mortgage lending, which is based upon an applicant’s ability to service mortgage payment and repay the loan from earned income, buy to let lending is often based upon the ability of a property to be rented to provide sufficient income to service the mortgage interest and associated expenses.
The Money Centre’s online buy to let quotation service calculates this for you and also provides an analysis of the property investment under consideration. To use this service click here.
However, if you don’t have access to the internet whilst negotiating a deal you may wish to use the following formula.
Monthly rent × 12 ÷ “Notional Rate %” ÷ Interest Cover % = Maximum loan amount (subject to the lenders maximum “LTV (loan to value)”
For the purposes of an easy example let us assume the following:
Purchase Price of property is £120,000
Monthly rent = £500
Notional rate = 4.99%
Interest cover = 125%
Most lenders publish this criteria.
£500 x 12 = £6,000 ÷ 4.99% = £120,240 ÷ 125% = £96,192
However, if the maximum LTV is 80% the maximum loan would be £96,000.
Purchase Price of property is £200,000
Monthly rent = £750
Notional rate = 4.99%
Interest cover = 125%
£750 x 12 = £9000 ÷ 4.99% = £180,360 ÷ 125% = £144,288
Even if the maximum LTV is 80% the maximum loan would still be £144,288.
Lenders will always use the lower figure of LTV or the rental formula.
Most landlords have a strategy of repaying their mortgages when their properties are eventually sold. Accordingly, lenders calculate maximum lending based upon rentals covering interest and leaving a margin for expenses.
Their first criteria is LTV. This is the maximum loan a lender will commit to, subject to their secondary criteria which is based upon “stress testing”.
Pay Rate: The amount of interest charge on the loan amount (often, but not always, the same as the notional rate).
Notional rate: An assumed interest rate. The pay rate may only be 1.99% (e.g. an introductory rate). However, the lender may well want to know that interest can still be serviced when the introductory rate comes to an end. The more conservative a lender is, the higher the notional rate will be. Note that some lenders do not use notional rates.
This is all well and good for potentially borrowing larger amounts, however, if you don’t want to fund higher rates of loan interest from earned income you may wish to apply your own notional rate based upon your own comfort levels.
For example, if the lenders pay rate is 1.99% and their notional rate is 5% you may be comfortable with this. However, you may choose to assume that interest rates could go up to 8%, in which case you may choose to base the maximum loan on your 8% notional rate.
Interest Cover: The minimum percentage by which rent must cover the interest payments.
Loan Amount: The amount required to borrow.
LTV: Loan to value (the percentage of loan amount compared to purchase price or value).
Loan amount X interest rate % ÷ 12 = monthly interest payment.
Loan amount = £100,000
Pay Rate = 3%
£100,000 x 3% = £3,000 ÷ 12 = monthly interest payment of £250.
You should also factor other costs of property ownership into every deal when considering affordability. These include ground rents and service charges, lettings costs, management fees, insurance premiums, accountancy, rental voids and maintenance.
As you grow your property portfolio it becomes more and more essential to understand these formulae. You may be able to cover negative cashflow on one or two properties but, the more properties you own, the bigger the problem can become.
If you own three or more properties you should seriously consider a Portfolio Review with one of our specialist Consultants. They have access to advanced software to project your portfolio based on a variety of scenario’s including interest rates, inflation, property growth etc. They will also be able to discuss strategies to minimise your risks and maximise your returns.
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