What is top slicing in buy to let mortgage borrowing?
And how can it help your application for a mortgage to buy a rental property?
The origin of the term is lost in the mists of time (or charcuterie), but in financial terms it refers to the use of part of a budget to fund another function.
In buy to let mortgage calculations many lenders are now allowing landlords to use some of their personal, earned income to make up for a shortfall in projected rental returns when applying for a mortgage.
Why is it needed?
Top slicing is a response to UK tax changes introduced in 2016 and 2017 which affected buy to let landlords.
From April 2016 stamp duty on second homes increased by 3%.
And from April 2017 then-chancellor of the exchequer George Osborne took a big bite out of landlords’ profitability by reducing the income tax relief on buy to let mortgages by 25% a year over the four years to 2020.
Anticipating the effect of the changes, in January 2017 the Bank of England's Prudential Regulation Authority (PRA) introduced stricter affordability rules on buy to let lending.
Calculating the profitability of your rental property
Previously, the interest coverage ratio (ICR) – the calculation used to demonstrate that the level of borrowing could be sustained by the projected rental income – was stress-tested usually at 125% with an assumed 5% interest rate across the board.
The effect of the new ICR
The new criteria meant that many would-be landlords just couldn’t make the sums add up.
This would be a wholeheartedly good thing if it’s saving a new-entry or "accidental" landlord from taking on a rental property that isn’t going to wash its face.
But when a HNW borrower is well-able to make up any shortfall in rental earnings, and is looking to a long-term increase in the value of a property as much as its current earnings potential, withholding mortgage funding just looks like turning away good business.
Hence lenders being prepared to be more flexible in these cases, and take earned income into account.
Top slicing: who it works for
If you’re a higher-rate taxpayer buying a more expensive property (such as in London and the south east) where rental income just isn’t going to be able to match the capital outlay, it may not matter to you that this investment is only just profitable.
Top slicing can be a useful mechanism that works around inflexible criteria to help you achieve your financial goals.
Top slicing: who it doesn’t work for
If you’re stretching your borrowing to the maximum with the aim of generating rental profit, and have very little leeway to cover unforeseen events, top slicing may not do you any favours.
And if you own four or more mortgaged buy-to-let properties you are classed as a portfolio landlord. In the future when you’re looking to refinance one of the properties many lenders will now require that all the properties in your portfolio must individually satisfy a profitability calculation (rather than the portfolio as a whole).
If top-slicing has been used in the financing calculations of one of your properties this could be problematic.
Get good advice
The buy to let market may be comparatively stable, but as the rules for funding become more complicated the need for good advice and an awareness of all the mortgage criteria available in the market is increasingly apparent.
At Clifton Private Finance our specialist buy to let brokers will look at the complete picture of your property finance needs, and propose the solutions which will work best for you.
Call us to arrange a convenient time to discuss your situation: