Will your mortgage go toxic if interest rates rise?

The big worry for buy to let landlords and homeowners is how their finances will cope when mortgage rates start to rise.

Many landlords are coping with their finances because mortgage rates have dropped – but they have two concerns.  First, is how much extra tax they might have to pay if interest rates stay low and they have no losses from previous years to set off against rental profits.

Next is what happens if mortgage rates go up with the bank base rate – especially if rental properties stand empty.

To help mortgage payers figure out how they will cope, here are stress tests that identify if your borrowing will go toxic:

TEST 1: Does your buy to let rent cover your mortgage by 125% at an interest only rate even if base rates hit 4%?

If it does, then you should be able to cope if rates go up. Buy to let lender The Mortgage Works suggests borrowing £132,000 at 80% loan-to-value on a buy to let valued at £165,000 needs rent cover of £686 per month.  We say that depends upon a lot of other factors including the basis upon which your interest rates are calculated and other costs associated with owning, letting, maintaining, insuring and managing your property.  The margin over the base rate also makes a big difference.  If you are paying 1.75% over bank base rate that’s very different to a borrower who is paying 3% or 4% over base.

TEST 2: Will your rent soak up interest rate rises?

A 0.25% mortgage rate rise on £132,000 a t5% interest only mortgage adds £27.50 to the monthly repayments.

The break even point for your mortgage is when the mortgage cost plus monthly expenses equals the monthly rent you can expect to charge for a property.

A £132,000 mortgage costs £550 a month interest only at a 5% interest rate. Add in insurance, letting agent fees and repairs and a couple of 0.25% base rate rises puts the monthly costs at around the rent charged.

TEST 3: Do you have a contingency fund to cover voids?

If you have no spare cash now to cover voids and contingencies like unexpected repairs, where will the cash come from to pay the bills if the property is empty?

TEST 4: Do you have a plan to pay off your mortgage?

Many buy to let landlords are relying on house price inflation and a buoyant market to cash in their investments when they retire. The current housing market would certainly put a brake on this … but do you have a plan B?

Unless your name is Carol Vorderman or you have a degree in maths you might find it difficult to calculate all of these figures accurately.  That’s why we’ve created some very simple ‘Number Crunchers’ to do all the hard work for you.  Click here to read more about this FREE functionality recently added to Property118.com

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