As originally published in
Mortgage Solutions.
Not all landlords are obsessed by yield. If they were, there would be very few private rental properties available in London and an oversupply of HMOs in student towns around the country. For some landlords, purchasing a desirable asset in a sought-after location is a more important factor of their investment than achieving a high yield.
For example, according to Which?, the NG1 postcode in Nottingham provides the best buy to let yields in the country, with an average yield of 11.99% and an average house price of £152,631. In Hampstead on the other hand, where the average house price is more than £1.6m, the average yield is just 4.20%. But this is still a popular area for investors because the location will always attract a good level of demand.
The trouble with investing in properties that deliver a low yield is that it can be difficult to make the interest coverage ratio (ICR) stack up on a standard buy to let mortgage.
One option to tackle ICR on low yielding properties is to roll up some or all of the interest. With a roll-up mortgage there are no monthly payments required as interest is rolled up to redemption and, any interest which is capitalised is not subject to a stress test, and so this can increase the client's borrowing capacity.
Rolling up all of the interest on a loan can ultimately reduce the amount an investor is able to borrow however, as the payment of rolled up interest will need to be factored into the maximum LTV.
So, for landlords with low rental yields, a blended product can be the ideal solution. This is effectively a loan that is structured so that some of the interest is serviced, but the interest on the remainder of the loan is rolled up. Because there are no monthly payments due on the rolled-up part of the loan, this element is not subject to a stress test. So, with a balance of serviced interest and rolled-up interest, it is possible to build a loan that fits the required stress test.
The roll-up element offers the opportunity for a client to maximise their loan amount and the serviced element offers a lower rate than the roll-up element. When the two are combined, the rates can be aggregated to give one set of loan terms, keeping things simple for you and your client.
So, if you have clients who choose to invest for long-term stability rather than yield, and need a flexible solution to tackle ICR, consider whether it would be appropriate for them to roll up some or all of the interest on the loan to achieve their lending objective.