Since I ran the article in my newsletter a few weeks ago about what banks look at when deciding if they’ll lend, I’ve had a few questions around Stress Testing (of buy to let mortgages) and how that works.
And, of course, this is an important subject because Stress Testing in effect set’s the maximum amount we can borrow.
If you want to do Buy to Let with BRR (Buy Refurbish Refinance), it’s the stress test which means that the upper limit of value is going to be around £200,000 (this isn’t a precise figure and don’t forget each bank uses slightly different figures and so the upper limit will be different for each bank).
And this why doing buy to let with BRR in London doesn’t really work.
Let’s first have a look at what Stress Testing and rental cover mean.
A typical lender might want to Stress Test at 5.5% and 125%.
What does this mean?
It means that the rent must be at least 125% of the mortgage payment assuming a notional interest rate of at least 5.5%.
In other words, if the interest paid were calculated at 5.5% on a loan, the rent received for the property must be at least 125% of the interest paid.
Confused? Let me show how this works using an example.
By the way, I hate maths and I’m not very good at it, but sometimes it’s a necessary evil. The good news is that if I can follow it, I assume most people can.
Let’s assume you buy a buy to let property (probably up north) for £100,000.
You are going to buy it using a 75% LTV buy to let product, interest only, at 2.29%.
So you will borrow £75,000 (75% of £100,000).
You will pay £1,717.50 in interest a year or £143.12 per month (£75,000 x 2.29/100).
But before the bank will lend you the money they will stress test it using the 125% and 5.5%.
This is how they will look at it.
First, they will work out what the interest on the loan will be at 5.5%.
So £75,000 (as before) x 5.5/100 is £4,125 per annum.
Which is £343.75 per month.
Now the bank will take that notional rental figure and multiply it by 125%
Mathematically that simply means multiplying by 1.25; so £343.75 x 1.25 = £429.69
So, in order for the bank to advance you the full £75,000 the rent needs to be at least £429.69 per month (125% of £343.75 per month).
BUT, and this is a big but, not all banks use 125%. Some are using 145%.
So let’s see what difference that will make.
Again, they will work out what the interest on the loan will be at 5.5%.
So £75,000 (as before) x 5.5/100 is £4,125 per annum
Which is £343.75 per month.
Now the bank will take that notional rental figure and multiply it by 145%
Mathematically that simply means multiplying by 1.45
£343.75 x 1.45 = £498.44
So, in order for the bank to advance you the full £75,000 the rent needs to be at least £498.44 per month (145% of £343.75 per month).
To be clear, none of this effects how much interest you’ll pay – you’ll still only pay 2.29% (in this example).
If you want to know what notional interest rate and rent cover figure a particular bank uses, you can usually find out by looking on their website.
Of course, in the real world, because you will be using a broker to find your buy to let (and other) finance, they’ll worry about all this for you, so you don’t need to think about it.
If you’d like me to introduce you to my very good broker please email me
and I’ll put you in touch.
Here’s to Successful Property investing
Peter
Peter Jones
(ex) Chartered Surveyor, author and property investor
PS. By the way, I’ve rewritten and updated my best-selling e-book, The Successful Property Investor’s Strategy Workshop, which is an account of how I put together my multi-property portfolio, starting from scratch and with no money of my own, and how you can do the same.
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