A buy to let stress test is a process that most landlords go through when purchasing a property to rent. But how is it used, and how does it affect your mortgage eligibility?

The stress income cover ratio (SICR) is the calculation lenders apply to determine your affordability of a buy to let (BTL) mortgage. SICR compares the amount you want to borrow with the amount of rental income you’ll receive and the interest you will have to pay on the loan.

It can get a little complicated, but it’s good to understand how lenders use this stress test to have a better idea of whether your buy to let mortgage application will be approved.

What is a Buy to Let Stress Test?

A Buy-to-Let Stress Test is a financial assessment conducted by lenders to determine if a potential borrower can afford mortgage repayments on a buy-to-let property under adverse conditions, ensuring that rental income is sufficient even in less favourable scenarios. It helps lenders mitigate risk and ensures that you will be financially prepared for fluctuations in the market.

How Does a Buy to Let Stress Test Work?

Lenders will evaluate your rental income from the buy-to-let property. This is usually based on the expected rental income as determined by a surveyor's assessment or the market rent for similar properties in the area.

The lender applies a "stress test" by simulating higher interest rates than the current market rate. This is to assess whether you can still afford the mortgage repayments if interest rates were to increase in the future. The specific rate used for the stress test can vary but is typically around 5-7% above the lender's standard variable rate.

Using the higher simulated interest rate, the lender calculates whether your rental income would be sufficient to cover the higher mortgage repayments. It also takes into account other expenses related to the property, such as maintenance costs, management fees, and insurance.

Why Lenders Apply the ‘Stressed’ ICR to BTL Mortgages

Lenders treat BTL mortgages very differently from residential mortgages, and you should expect higher interest rates. The amount you can borrow for a buy to let mortgage will depend on how much rental income you will receive from the property.

Since 2017, changes introduced by the Prudential Regulatory Authority (PRA) have meant lenders have to apply much stricter criteria for BTL borrowers:

• When measuring affordability for buy to let mortgages, lenders require a ‘buffer’ in your rental income of either 125% or 145%. This is the income cover ratio (ICR) and is applied to ensure a borrower has enough surplus income from the property to pay for repairs, non-payment of rent, service charges etc
• Lenders will also apply a ‘stress test’ to your application, factoring in your ability to pay an interest rate of between 5.5% to 6%, even if the actual mortgage rate is lower. This is the stress income cover ratio (SICR) and is applied if interest rates do rise to that level.

How Do You Calculate the SICR on a Buy to Let Mortgage?

A typical stress test conducted by a buy-to-let lender uses a Stress Interest Cover Ratio (SICR) of around 5.5% and a Rental Cover Rate of between 125%-145%.

Based on a loan of £200,00 with stressed ICR at 5.5% and rental cover at 125%

Step 1: Work out the annual interest

Loan amount £150,000 x ICR 5.5% = Annual interest of £11,000

Step 2 – Work out the minimum Annual Rental Income

Annual interest £11,000 x rental cover 125% = Minimal annual rental income £13,750
Or minimum monthly rental income of £1,146

March 2024 Buy to Let Market Update

• Before 2023, the stress rate was around 4%, and landlords could borrow significantly more. For instance, about a year ago, a basic rate taxpayer could borrow around £309k for a property based on the average UK rent of circa £1,300.
  
  
• At 75% Loan to Value, that could buy roughly a £400k property, which you would expect to comfortably provide £1,300 in rental income. So it made sense, and the maths added up.
  
  
• The BTL market faced challenges in 2023, with landlords finding it difficult to borrow due to stringent stress testing measures. However, stress testing has eased up in recent months, and there is growing confidence in the buy-to-let market in 2024.

Did You Know? 

Generally, 5-year fixes are typically the cheapest deals available for buy-to-let mortgages. The Prudential Regulation Authority allows mortgage providers to apply a lower stress test if the mortgage term is over five years.

Because of this, you may find a rare 2-year fix or tracker mortgage that seems more suitable, but in most cases, a five-year fix will work out as a more affordable option, purely because of the more lenient stress testing criteria applicable. 

How to Borrow More: Buy to Let Topslicing

One of the largest lenders on the market has announced they are including topslicing in their affordability calculations. Topslicing can play a crucial role in making buy to let investment more accessible because it allows you to supplement projected rental income with part of your employed earnings.  

This can be advantageous for portfolio landlords and new property investors alike because it allows you to borrow more with a smaller deposit or include rental earnings from higher-yielding properties in your portfolio.  

Without top slicing, it can be challenging to acquire a buy to let mortgage with a small deposit. Rental yields alone are typically not enough to secure a large mortgage at 80% LTV or higher. 

With this lender, topslicing is only available to those with a household income of £100k or more (e.g. singular income of £100k, or two £50k incomes or equivalent), but it certainly opens a few more doors for high earners who are looking to invest in rental property but are struggling with affordability.

How Do BTL Lenders Treat Tax When Assessing Your Affordability?

The Prudential Regulatory Authority expects lenders to take a borrower’s income tax into account when assessing affordability for a buy to let mortgage. So, your tax rate status is what determines the stressed income cover ratio used to assess your BTL affordability.

Basic rate taxpayers can expect lenders to apply a stressed income cover ratio of 125% as there is less of a burden on their rental income.

Lenders will usually assess higher-rate taxpayers at a stressed ICR of 145%, while additional-rate taxpayers might be assessed at up to 167%.

This means that if you fall into the higher tax rate category, you will need more rental income to break even.

What Happens if I Fail the Stressed ICR Test?

If your buy to let property doesn’t meet a lender’s standard stressed ICR test, it may not mean your mortgage application will be refused outright.

A number of specialist lenders can ‘take a view’ to address a stressed ICR shortfall.

• This is known as 'Top Slicing', when a lender assesses your income, considering all sources of diversified income and wealth, to determine that a borrower would still be able to make the mortgage repayments even if things took a turn for the worse. Not all lenders are willing to use the top-slicing approach, but a specialist mortgage broker will have good relationships with those that do.
• Another factor that may influence a lender’s willingness to overlook a ICR shortfall, is if the loan to value is lower. If borrowers can put down a 35% deposit, the stress rate may be reduced. Similarly, if a longer-term mortgage product of 5 years or over is on the table, stress rate requirements can be lowered.
• For portfolio landlords, lenders can take a wider view of the situation if, for example, one property in the portfolio is weaker on rental income than the others. The stronger properties can often make up for a slightly weaker one.

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