ICRs, Fees And Interest Rates

Paul Brett Managing Director, Intermediaries

We all know the mortgage market has been in a state of flux since the disastrous mini-Budget on 23 September with rates spiking and lenders pulling products.

The situation is a little calmer now since Rishi Sunak became the new Prime Minister but uncertainty still persists and the economy remains fragile. Mortgage products are returning to the market but are much higher than a couple of months ago. The reality the mortgage market face is that this is now the new norm.

Bank of England base rate has risen eight times in a row to a 13-yearhigh of 3% and swap rates have been escalating all year. This has caused a dilemma for lenders trying to price mortgage products. The simple fact is we can’t provide mortgages at a loss so have no choice but to raise rates.

But buy-to-let lenders are faced with another quandary, which 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% to 145% 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.

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. This is likely to be an issue for some landlords remortgaging as the higher rates may mean they no longer meet the ICR.

As lenders we have to be make sure the ICR calculations 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 was lower and the rate higher (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).

ICR calculation

This example illustrates the difference in ICR rental requirements from earlier this year to now.

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 a rate at 6.59%, the minimum rental income is £1,029.

Impact on ICR of different fees and interest rates

Varying the fee and interest rate on a £150,000 five-year fixed rate mortgage 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 Landlord borrowers will not only have to pay higher rates when they remortgage or purchase a property, they must also be mindful of the rent they charge in order to secure a mortgage. The impact this has on yields could be significant for some landlords and although they can still make a profit, it might not be as much as it was a few months ago.