What landlords and homebuyers need to know about stress testing

Mortgage Advice Bureau takes a look at stress testing. What it is, why testing affordability is important, and its impact on borrowers and landlords.

Related topics:  Landlords,  BTL
Rachel Geddes Mortgage Advice Bureau
14th April 2023
Stress Test 685

The learning objectives for this article are to:

  • To understand the difference between LTI and LTV
  • To recognise how the changes in FCA guidelines could impact borrowers who had previously been rejected for a mortgage
  • To be able to describe why the official stress test recommendations were withdrawn

For those looking to purchase a property, it is essential to understand the financial process involved. Stress testing used to be a significant factor in this, and it aimed to ensure that borrowers could afford their mortgage payments, even if rates were to rise.

Although the formal stress test has been scrapped, lenders still need to assess affordability and consider your income when looking at your mortgage application. How do lenders assess your finances without a stress test?

Stress testing explained

Introduced in 2014, stress testing required borrowers to demonstrate that they could afford monthly repayments, even if mortgage rates increased by 3% above the standard variable rate of their lender.

Though no longer a formal requirement, the loan-to-income ratio remains in place.

The LTI limit puts a restriction on the number of mortgages a lender can issue to incomes greater than 4.5 times.

Understanding your LTI

Lenders use LTI to assess how much a borrower can borrow based on their income. LTV, or loan-to-value, which you’ll hear as well, is different. LTV compares the size of the mortgage with the property value.

LTIs for landlords

It’s important to understand that buy-to-let properties usually require an LTV of 75-80%, meaning you’ll need a 20-25% deposit. Knowing both ratios is crucial when applying for a mortgage, affecting how much can be borrowed and the deposit size.

Why the official stress test was scrapped

The Bank of England undertook assessments of their mortgage affordability tests, including stress tests, in 2022. Following the review, the Financial Policy Committee withdrew its stress test recommendations. Rising property prices and the likelihood of more rejected applications due to stress tests played a role in the decision.

The impact on borrowers

Though stress tests are no longer required, lenders must comply with FCA guidelines. This means making a reasonable assessment of a borrower's affordability and offering financial products that do not disadvantage them. While these changes mean that some previously rejected applicants may now qualify for mortgages, others could also receive larger mortgages, which comes with its own risks. This is why it’s essential for lenders to have conversations with applicants about their finances to ensure responsible lending.

Importance of testing affordability

The critical aspect of stress testing was to test overall affordability and though it had its limitations, lenders still need to ensure that borrowers can afford their mortgage payments, even if interest rates increase.

Interest rates may increase when fixed-rate mortgages end, and monthly repayments can fluctuate for variable-rate or tracker mortgages. Stress tests aim to guarantee that borrowers can afford repayments, even with significant fluctuations.

Impact on landlords

Buy-to-let mortgages are based on the expected rental income of the property, with lenders typically wanting rental income to be 125% of the monthly mortgage payments. The loan-to-value that lenders require may be impacted if the rental income is not high enough, thus requiring a larger deposit.

Criteria for assessing landlord affordability typically include:

  • Income
  • Deposit amount
  • Employment status
  • Age
  • Credit score
  • Location

Advice for applying for a buy-to-let mortgage

Researching various lenders and their offerings is vital before making any decisions. A mortgage adviser can provide guidance on the market, available options, and lenders who best suit the applicant's circumstances. It is also crucial to understand the costs involved in maintaining a property, including repairs, maintenance, insurance, agent rates, tax, and legal fees.

Stress testing remains a crucial factor in the mortgage application process and understanding its impact on borrowers and landlords is essential for making informed decisions when buying property.

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To recap, this article has helped you...

  • To understand the difference between LTI and LTV
  • To recognise how the changes in FCA guidelines could impact borrowers who had previously been rejected for a mortgage
  • To be able to describe why the official stress test recommendations were withdrawn
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