A stress test is the term given to the process by which lenders assess the sustainable affordability of a loan to a buyer. Required by law to undertake such affordability tests as a result of legislation following the 2008 credit crunch and housing crisis, stress tests are there to protect the borrower (and the lender) for entering into ill-conceived or risky mortgage arrangements.
The standard mortgage stress test will consider household income, monthly outgoings, number of incomes in the household and the likely impact on affordability of rises in interest rates, etc. The buy to let borrower is usually relying in large part on income derived from the letting of the property and so a buy to let stress test will usually focus on the rent receivable and the interest payable.
In the past, a standard buy to let stress test has required that rent received be 125%, thus allowing a margin for additional costs and to build a buffer in the event that the property becomes vacant for a short period of time. In addition, a notional rate of interest will be assumed (higher than the existing rate) so as to allow for a cushion in the event that interest rates rise in the future.
In large part due to recent changes in the tax structures applied to buy to let income, lenders in this market have been keen to revise their stress tests to take account for the additional cash flow burden put upon the high rate tax payer with a buy-to-let mortgage and the increased likelihood that mortgage rates will increase in the future.
Some lenders have already increased their stress test margin to 145% rental cover and 5.5% notional interest rate, thus effectively reducing loan to value and limiting an investor’s buying power.
The good news is that, at present, borrowers financing their buy to lets through limited companies will not be hit by the Government’s new tax rules. Therefore, lenders are not necessarily bringing the increased stress test across to their corporate mortgage rates.
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