Meeting the affordability checks for a buy-to-let mortgage can be hard in the current market. The amount payable for monthly mortgage payments has increased in many cases due to the higher interest rates. In comparison, however, the rental amounts charged have had to come down to help tenants cope with the high cost of living. To ensure that landlords can afford to take on new buy-to-let mortgages, many lenders allow top slicing in their criteria.
What is top slicing?
When applying for a buy-to-let mortgage, the rental income for the property is taken into account for the affordability calculations. This might not be high enough to cover the monthly mortgage payments, however, restricting how much you can borrow. As a solution, some lenders use top slicing to make up the shortfall. This is when they look at any surplus personal income you may have and add it to the rental income.
How does top slicing work?
Lenders generally look at your expenditure and ascertain the surplus needed to make up the shortfall in rental income. The amount of disposable income you have to cover this surplus, whether earned or from your portfolio, is known as the top slice of your income. The rental income normally required for a buy-to-let mortgage must meet a specific interest coverage ratio. We’ll explain what this is below.
What is the interest coverage ratio (ICR)?
The ICR determines your ability to pay the interest on the mortgage loan from a lender’s point of view. The ratio is based on the gross rental income compared with the mortgage interest repayments. A minimum ICR of 125% is generally required for basic rate taxpayers and limited companies. A minimum ICR of 145% is usually insisted upon for higher rate taxpayers although some lenders stipulate 160%. A stressed interest rate is used to calculate the ICR and this takes any potential interest rate increases into account. If the ICR shows the lender that the rental income alone is not adequate to cover the monthly repayments, they can use top slicing to add your personal income to this amount.
Affordability assessment for top slicing
A lender will look at your income from different sources as well as the rental income from the property you’re buying. These sources can include any rental income received from other properties you own, your surplus salary income, a pension income, savings accounts or investments. Your expenditure will be looked at as well as other factors. These can include the number of properties you own and whether you have any dependants. Lenders vary on their criteria but they all need to ascertain that you can afford the mortgage loan and interest payments as well as being able to cover any void periods, maintenance work, tax bills and fees relating to the purchase. Lenders generally offer a maximum loan-to-value ratio of 75%. This means that you need to pay a deposit of at least 25%.
Lender restrictions for top slicing
Some lenders have restrictions when agreeing to the use of top slicing for a buy-to-let mortgage. For example, they won’t accept first-time landlords or approve a mortgage for a new build or an HMO. You may have to earn a minimum amount, such as £75,000 per year, or have to live in the property yourself as shared accommodation with your tenants.
Is top slicing right for you?
If you have disposable income, top slicing allows you to secure a buy-to-let mortgage when the property’s rental income falls short of the ICR. This means that there’s no need to miss out on an investment opportunity that comes along. It provides you with flexibility with the amount you can borrow. This is especially useful if property prices are inflated in the area you’re buying in.
However, you need to make sure that the long-term potential of the property you’re buying is worth it. Buy-to-let mortgages are usually taken out on an interest-only basis. This means that the entire loan has to be repaid at the end of the term.
You also don’t want to stretch your finances too thin when you combine both the rental income and your surplus income to cover the monthly mortgage payments. This can be especially problematic if something unforeseen occurs that’s a big expense. Another point to bear in mind is that using top slicing can affect your portfolio if you wish to refinance one of your other properties in the future.
Speak to an expert about top slicing
If you can’t quite meet the affordability requirements for an investment property you wish to buy, give our mortgage brokers a call on 01322 907 000. They’ll take an in-depth look at your circumstances and discuss the ins and outs of top slicing with you. If you’re happy to proceed, they’ll submit your application to a lender who offers top slicing and negotiate the best deal on your behalf.