How does rental income affect the amount you can borrow?

Thu 23 Jul 2015

Brian Murphy
Head of Lending at MAB

The relationship between rental income and the amount you can borrow to finance your property investment is one of the most important, from a lender’s perspective.

One of the first checks lenders make when you apply for a buy-to-let mortgage is whether the rental income is high enough to cover the repayments and associated costs of letting the property.

Although it can vary, lenders usually want rental income to be 125 per cent to 130 per cent of the amount you will be required to repay on the mortgage each month.

Knowing this, it makes sense for you to check these figures for yourself, before you apply for a buy-to-let mortgage.

Here are three steps to calculating the monthly rental income your property can achieve.

Step One

If a property you are interested in buying is already being let out, check how much rent the tenant is currently paying, but don’t assume that this is the maximum you could achieve. Many landlords do not increase rents each year for existing tenants, particularly if the tenant has been in the property for several years. Local letting agent websites or property portals such as www.rightmove.co.uk or www.zoopla.co.uk will advertise properties for rent similar to the one you are looking to buy, so look at these to get a better idea of what you could achieve on the open market.

A good tip when searching online is to check the ‘let agreed’ box, to see properties that have actually let, as that is a good indication that the advertised rent level is fair.

Local letting agents can also be very helpful, as long as they are experienced at renting properties similar to the one you are considering. Bear in mind that anyone can set up as a letting agent - they don’t have to have any qualifications or experience, only to join a Property Ombudsman scheme – so look for self-regulated agents, like Leaders, who are members of NALS, ARLA, or are RICS registered, so you can be confident their valuations are reliable.

Step Two

Use our mortgage calculator to find out how much your mortgage repayments would be if you were to buy a property for a certain amount. Most buy-to-let mortgages are taken out on an interest-only basis as this is tax deductible. This means paying the interest on the mortgage loan, rather than also paying back a portion of the capital borrowed.

Step Three

Once you know the monthly rent levels and the cost of the repayment, you can calculate whether the rent is more than 125 per cent of the mortgage cost. Simply divide the rental income by the repayment amount, for example, £700 rent, divided by a £500 mortgage cost gives a ratio of 140 per cent.

Here is a full example, with the other costs and calculations you will need, assuming a purchase price of £175,000 and monthly rental income of £700 for the property:

  • A 25 per cent deposit would be £43,750
  • The remaining 75 per cent mortgage would be £131,250
  • Rates for buy-to-let mortgages vary, but we can assume a rate of between three per cent and five per cent
  • Most people take out a mortgage for a 25-year term.

Visit www.leaders.co.uk/mortgages and complete a mortgage calculator to find out how much your monthly repayments would be.

At three per cent, this would give an interest-only mortgage cost of £328.12. In this case the rental income of £700 gives a rental income to mortgage cost ratio of 213 per cent.

If, however, the rental income was only £500 and the mortgage interest rate was five per cent, at £546.67, the cost of the mortgage interest would be more than the rental income. In this case, it may prove very difficult to find a lender prepared to finance the purchase.

For additional advice on mortgages, please call 0330 2210200.

There is no guarantee that it will be possible to arrange continuous letting of the property, nor that rental income will be sufficient to meet the cost of the mortgage.

Your property may be repossessed if you do not keep up repayments on your mortgage.

There will be a fee for mortgage advice. The actual amount you pay will depend upon your circumstances. The fee is up to 1% but a typical fee is 0.3% of the amount borrowed.