Coping with the headache of ICRs

The rise in Bank of England base rate and swap rates has increased the cost of lending and the mortgage market has been particularly impacted.

Unfortunately, mortgage rates have had to go up, but in the buy-to-let market, there is another issue affecting affordability and that is the Interest Coverage Ratio (ICR). This is a regulatory requirement set by the Prudential Regulatory Authority (PRA) and lenders have to apply it to every mortgage application.

Landbay is a non-bank buy-to-let lender and we do not have to be regulated by the PRA, but nevertheless, we do follow all of the regulations set. This is important for our integrity and means we can also work with funders who are PRA regulated.

Based on a client’s tax position, lenders vary their ICR margins between 125% to 145%. This is then stressed against the prevailing mortgage interest rate plus a margin or a nominal set interest rate.

As a result of the rise in mortgage rates, the rental requirements will also be higher to meet the ICR. This is important as it dictates the borrowing potential for a landlord. It can restrict borrowing, in many cases below that of the borrower’s existing debt.

As lenders, we must ensure the ICR calculations are fit for both the borrower and us. One way to do this is to charge a higher fee upfront fee 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. It should be noted that adding the completion fee to the loan will erode the borrower’s capital if not managed correctly and cost a little more over the initial offer period in interest on the fee itself. 

Here are some examples illustrating the effect of different rates and fees on the ICR.

ICR calculation

In March 2022, a £150,000 five-year fixed rate mortgage at 2.99% – ICR at 125% requires a minimum rental income of £467.

In November 2022, with the rate at 6.59%, 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 4% – 6.49% rate = rent required £1,014
• Fee 3% – 6.69% = rent required £1,045
• Fee 2% – 6.89% = rent required £1,076

If you would like to understand more about the effects of higher interest rates on ICRs, or would like to discuss a case, please get in touch with your local BDM.