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How to calculate Interest Cover Ratio (ICR) for landlords?

Buy to let mortgage calculator on a macbook with a woman taking notes

What is the definition of Interest Coverage Ratio (ICR)?

The ICR, also called the Interest Cover Ratio or the Interest Coverage Ratio, is used to assess how a landlord’s ability to pay to be athe mortgage on a buy-to-let rental property, whether it’s a single let or an HMO. The ICR is a percentage of the expected monthly rental income, in relation to the “stressed” monthly interest payment, which takes into account likely future interest rate increases.

The ICR is used to measure affordability for a buy-to-let landlord, and assess how easily a landlord will be able to pay interest payments as they fall due. In other words, whether the rental income to be earned from the property will be enough to support the monthly interest cost of the mortgage payments using an interest coverage ratio (ICR) test.

Mortgage lenders use the ratio to assess the resilience of the landlord’s portfolio to increases in interest rate.

When calculating the maximum borrowing, it will typically include any product fees added to the loan (eg see The Mortgage Works and Paragon).

The PRA Underwriting Standards for Buy-to-Let Mortgages for landlords

The Prudential Regulatory Authority (PRA) of the Bank of England issued rules for calculating the minimum ICR in September 2016 in Supervisory Statement SS13/16, Underwriting standards for buy-to let mortgage contracts.

The Standards state that lenders should take into account rental demand and typical rent levels within the property’s locality, verified by an independent qualified valuer. The valuer should use “automated valuation models or evidence of an existing rental agreement, subject to appropriate policies, controls and risk management”.

What do lenders take into account in ICR calculation for buy to let mortgages?

Lenders have some flexibility in the data and information they choose to determine the minimum ICR threshold for a mortgage, including portfolio level data and data based on models. The Prudential Regulation Authority (PRA) advises that lenders should take into account the following costs, where the borrower is responsible for payment:

  • management and letting fees, council tax, service charge, insurance,
  • repairs
  • voids
  • utilities
  • gas and electrical certificates
  • licence fee
  • ground rent
  • any other costs associated with renting out the property irrespective of whether the borrower is an individual or a company.

How does a landlord’s tax rate affect the stressed ICR?

Until 2017, lenders typically looked for a minimum ICR of 125% calculated using an appropriate stressed interest rate (stressed ICR) for all buy to let landlords.

The stressed ICR of 125% reflects the amount of gross rental income required for landlords to break even, factoring in the costs of mortgage repayments (including a potential increase in interest rates), tax and property maintenance.

However, following the changes to Mortgage Interest Tax Relief (MITR), phased in between 2017 and 2020, or the infamous Section 24, individual landlords could no longer offset the full mortgage interest payments against their rental income for tax purposes. Instead, they were only permitted to a tax credit equal to 20% of their mortgage interest repayments.

This had the effect of increasing the tax bill for higher-rate taxpayers, and higher-rate taxpayers now need more rental income to breakeven.

This means that an acceptable stressed ICR for higher rate taxpayers is usually 145%, while additional rate taxpayers might be assessed at up to 165%.

The interest coverage ratio formula and percentage do however vary according to the lender. For instance, The Mortgage Works applies a stressed ICR of 125% for basic rate tax payers and limited companies for single lets, and 160% for higher rate tax payers for single lets, and 175% for an HMO and limited company HMO, as of 26 March 2024. Click here for the ICR policy of TMW.

The rules also differ for portfolio landlords, who are borrowers with four or more separate mortgaged buy to let properties, whether in their own name of via a limited company. Here is a link to the portfolio landlord criteria of The Mortgage Works.

what does interest cover ratio (ICR) mean for landlords? with woman using macbook to calculate BTL mortgage
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