Both Bank of England base rate and swap rates have escalated causing a dilemma for lenders trying to price mortgage products. We can’t provide mortgages at a loss, so have no choice but to raise rates.
But another dilemma faced by buy-to-let lenders is the interest coverage ratio (ICR), a regulatory requirement set by the Prudential Regulatory Authority (PRA).
Although many non-bank buy-to-let lenders, like ourselves, are not regulated by the PRA, we nevertheless follow all of the regulations set. This is important for our integrity and means we can work with funders who are PRA regulated.
Lenders vary their typical ICR margins between 125 per cent to 145 per cent based on a client’s tax position. This is then stressed against the prevailing mortgage interest rate plus a margin or a nominal set interest rate.
ICR ‘causing a headache’
It is the ICR which is causing such a headache in the market as it is this which dictates the borrowing potential for a landlord.
With the rise in interest rates, this means that in order to meet the ICR, the rental requirements will also be higher. What is happening now is the ICR calculations dictate that the borrowing is restricted, in many cases below that of the borrower’s existing debt.
As lenders, we have to make sure the ICR calculations are fit for both us and the borrower.
One way to do this is to charge a higher fee upfront fee in order to have a lower interest rate, as the lower the mortgage interest rate is the lower the rental stress rate is.
Essentially, the total overall cost will be similar over the initial offer period if the fee is higher, and the rate is lower than that of normal pricing models we’ve previously seen (albeit adding the completion fee to the loan will erode their capital if not managed correctly and cost a little more over the initial offer period in interest on the fee itself).
Here are a couple of examples to illustrate what I mean.
ICR calculation
In March 2022, a £150,000 five-year fixed rate mortgage at 2.99 per cent – ICR at 125 per cent requires a minimum rental income of £467.
In October 2022, with a rate at 6.59 per cent, the minimum rental income is £1,029.
Impact on ICR of different fees and interest rates
Keeping with a £150,000 five-year fixed rate mortgage, varying the fee and interest rate would require the following minimum rental income to meet the ICR:
Fee two per cent – 6.49 per cent rate = rent required £1,014
Fee three per cent – 6.69 per cent = rent required £1,045
Fee two per cent – 6.89 per cent = rent required £1,076
