Top-slicing or ‘income top-up’ uses an applicant’s income to supplement affordability when the rental income is insufficient to cover the lender’s rental affordability calculation.
More than half of buy-to-let (BTL) mortgages are arranged on a five-year fixed rate as an alternative when rents are short, but if early repayment charges (ERCs) lock a client into a five-year deal it may not be the most appropriate.
A couple of lenders, such as Foundation and Precise, offer five-year fixed rates with only three years of ERCs. This benefits the borrower with a rental calculation based on five years but a commitment for only three years, however these products are few and far between.
Many lenders now have some form of offering, but income-based BTL products are not used as much as anticipated.
Why not? Maybe because the way they are calculated, and some of the conditions they come with, can make the calculation of affordability very complex.
If advisers identify a shortfall in the standard rental calculations there are a number of criteria points to consider in order to establish whether a top-slicing BTL option is a solution.
Minimum income requirements
Most lenders complete a personal income and expenditure calculation to establish any surplus income.
Advisers therefore need to gather the full details of income and expenditure up front.
Some lenders have a minimum income requirement. For example, they may only allow rental income top-up for those earning £50,000 or more (such as Metro and Zephyr).
Zephyr and Precise will, however, look at surplus property rental for the top-up, rather than just other earned income.
Some lenders have additional income top-up criteria. For example, Vida and Kent Reliance do not offer their products to portfolio landlords who hold four or more BTL properties.
In some respects this is understandable, because the surplus income can only cover so many properties that have rental shortfalls and there will be a greater risk as rates rise.
It is, however, good to see new products, such as Precise’s, come to the market without this restriction and with a different affordability model because this creates choice.
Rental coverage requirements
Another complexity is that, in almost all cases, there will still need to be a minimum level of rental coverage.
For example, Kensington will allow top-up to be used but only if the rent already covers the mortgage by 125 per cent as a minimum—although they will offer their products to portfolio landlords and limited companies.
The complexity arises because each lender’s minimum rental coverage is different.
Among the better lenders are Precise at 110 per cent, Vida at 115 per cent, Bluestone at 112 per cent and Kent Reliance with no minimum.
What they base this on can vary. For example, some base it on a notional rental calculation of 5.5 per cent and some on the pay-rate of the product.
With so much variance between lenders, it’s no surprise that the products allowing the applicant’s income are not as widely used as they could be.
To help, some lenders now offer a calculator on their websites to make it easier for advisers to navigate this area.
It is important that advisers don’t always default to a five-year fixed rate and instead consider the other options where they may be the most appropriate recommendation for their clients.