Dear Delia

Dear Delia Following the past three Bank of England base rate increases, a number of my buy-to-let clients aren\'t generating sufficient rental income to meet lenders\' rental cover requirements. This is particularly the case at 85% LTV where in some cases the rental income barely covers 100% of the monthly mortgage payment. What would you advise?

Delia says:
This is a problem many landlords face, but there are solutions as Katie Tucker of John Charcol and James Taylor of West Bromwich point out.

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Intermediary response
Katie Tucker is a product specialist at John Charcol

The starting point in assessing a buy-to-let case is the level of rental income that can be achieved.

No longer can intermediaries simply source the best product for their clients’ circumstances, particularly at the 85% LTV level, without first assessing rental cover as this can significantly limit the opportunities available.

Lenders have differing views on how to remain competitive with rental cover while still pricing to cover risk. Underwriting methods vary from 100% rental cover at pay rate to taking personal income into account. More recently, there has emerged a fashion for lenders to offer low rates with higher arrangement fees to compensate.

Bristol & West and Bank of Ireland ask that the rent covers 100% at pay rate and are offering standard 85% three-year fixes at 5.59% and 5.89% respectively.

While this allows these lenders to continue to make a profit on the rate, they run the risk of clients having little or no margin between their mortgage payments and rent, particularly as both lenders only ask that an applicant has 15,000 in personal income which does not have to be verified.

If you recommend a product of this sort, you must be satisfied that your clients can meet the cost of a few months’ rental void.

GMAC-RFC offers its product range with a variety of arrangement fees so brokers and applicants can choose the one that best suits. Its standard fee for a 125% rental cover buy-to-let product is 795, but for a fee of 1,295 it will allow 110% rental cover at base rate plus 1% or a 1,495 fee, the cover for which only needs to be 100% of base rate plus 1%.

GMAC-RFC also offers a stepped tracker with 100% rental cover at the initial 5.24% pay rate, useful for those cases where rental income is stretched.

However, clients will be tied in for a further two years at base rate plus 0.99% so you need to be comfortable that they can afford any shortfall should rental income not cover mortgage payments after the initial three years.

If your clients have substantial personal income, West Bromwich allows borrowers to use their excess personal income to top up any rental shortfall, as do Cheltenham & Gloucester and Abbey.

On the other hand, if your clients are struggling, Platform and UCB Homeloans both offer self-cert products whereby rental income does not have to be declared at all. Of course, these come with rates to reflect circumstances but they remain popular.

Lender response
James Taylor is mortgage product manager at West Bromwich

Rental incomes have remained fairly static and have even fallen in some areas in recent months. The recent base rate increases have exacerbated this problem, because a number of leading buy-to-let lenders work out rental cover calculations on a rate linked to the base rate.

However, at West Brom for Intermediaries our rental income requirement is no longer linked to the base rate. Instead, all we ask is that the monthly rental income meets 100% cover using a notional rate of 5.95%.

That means a client wishing to borrow 150,000 needs to be able to generate at least 744 per month in rent (150,000 x 5.95%, divided by 12 months).

If a client achieves at least 744 per month, we can proceed with no minimum income requirements. But what if the client only manages to generate a rental income of 650 per month, equal to 87% rental cover?

In this case you will need to use a lender that calculates rental cover at the product rate. But for the example above, to fit their criteria you will need a rate of about 5.2% with 100% rental cover at pay rate. This is pretty hard to come by without paying a large arrangement fee.

The alternative is to use lenders that allow you to use part of the applicant’s earned income to cover the rental shortfall, what is commonly known as top-slicing. We allow you to do this and the calculation is pretty straightforward.

Simply take the applicants income, for example, 30,000, multiplied by a 4 x income multiple equals 120,000. Then just deduct their outstanding residential mortgage, say 70,000, which leaves 50,000 available to cover the rental shortfall.

So in the example above, 650 rent per month means the client could only borrow 131,000, but when you take into account the 50,000 available from adding in their income, they can comfortably afford to borrow the 150,000 needed.

If the base rate is increased again in the next couple of months, as a number of commentators suggest, the proportion of the mortgage payment that rental income is able to cover will continue to decrease.

This will, in turn, require clients to either raise a greater deposit themselves, use some of their personal income to cover the shortfall or pay an increased arrangement fee on a product that only requires 100% rental cover.

The good news as far as West Brom is concerned is that even if the base rate does increase, our rental calculation will remain unchanged at 100% using 5.95%.