Top slicing trick may be the answer for landlords
Richard Campo,
Founder of Rose Capital Partners
It has been a surreal month or so for the mortgage market. The decisions made by the Government, the former Prime Minister and former Chancellor have turned the mortgage world upside down.
With expectations at one point that the Bank of England would hike Base Rate as high as 6% within a year, it was not surprising to see lenders of all sizes rapidly pull their product ranges and relaunch deals at significantly higher rates. It’s caused a lot of stress and upset for those looking to purchase their own home, but the impact hasn’t been isolated to the residential market – landlords have been affected too.
Rising rent requirements
One of the big impacts of the recent disruption for landlords has been that affordability tests are now more tricky to navigate.
As with residential mortgages, any lender offering a buy-to-let mortgage wants to establish from the outset that the loan is affordable. However, the way they go about this is rather different from a normal mortgage, including the use of the interest cover ratio (ICR).
In simple terms, the ICR is how the size of the expected rent compares to the cost of the interest being charged on the mortgage. Lenders will set a minimum level for the ICR, often of around 145%, meaning that the rent you bring in each month will need to be almost 1.5 times the size of the interest payments on your buy-to-let mortgage.
This calculation has become more difficult to pass in recent weeks, courtesy of the increases to mortgage interest rates. As the rates go up, so too does the amount being charged on the loan, meaning that rents may have to increase too – and substantially in some cases – in order to meet the lender’s requirements.
Top slicing
There may be a solution however in the form of top slicing. This is where the lender allows you to use some of your personal income – what they define as ‘surplus’ income, meaning it isn’t already devoted to paying off your regular bills – to top up that shortfall.
It can provide some landlords with a little breathing space, allowing them to retain quality tenants without having to hike the rents to levels which would be unaffordable for them, ensuring that the investment property continues to perform.
The rules around top slicing will vary between different lenders. It’s common for lenders to set a minimum income that you need to earn from outside your rental properties – say £50,000 a year – before you would be eligible for top slicing, for example.
Similarly, some lenders will only consider it an option for experienced landlords, or on certain types of properties.
Taking advantage of top slicing
It’s worth pointing out that not all lenders will consider top slicing for landlord borrowers, instead preferring to rely entirely on the ICR check. As a result, you will inevitably have a somewhat smaller range of options from which to choose than if your rental income offered a more significant coverage of the interest payments on your buy-to-let mortgage.
There is also the danger that at least some of these lenders may step away from top slicing, or at least introduce more stringent criteria around when it can be used. It seems almost certain that house prices will fall next year – earlier this month Zoopla suggested that if rates stay at their current level then it’s possible home values will drop by ‘double digits’, and they are certainly not alone.
Coupled with the general gloomy forecasts for the economy as a whole, it wouldn’t be particularly surprising to see lenders adopt a more cautious approach to their lending, including the instances when they will consider top slicing.
Moving quickly with experts
As a result, now is a really good time for any landlord to consider their refinancing options. If the market does in fact deteriorate, then delaying those decisions could not result in more costly options than putting a plan in place today.
Given the rapid rate at which this market changes, as well as the diverse approaches adopted by different lenders, partnering with experts like Rose Capital Partners is a smart move. Brokers who work with this segment of the mortgage market every day are well-placed to help you identify the lenders and products best suited to your current circumstances, as well as help you time your switch correctly.