How equity is calculated to raise finance

THE QUESTION

I have a BTL property that is worth £325k and has a mortgage of £227k. I was recently trying to raise finance to purchase another property and wanted to see if I could release some equity from this BTL to raise the equity.  

My lender asked me how much rent I charge (£1150 pcm) and said I wasn’t able to get any equity.  I asked how much the rent would need to be to get any equity and they couldn’t tell me.  So how do mortgage lenders calculate this?

THE ANSWER

Mortgage lenders are now instructed by the Prudential Regulation Authority (PRA) to use a prescribed formula to calculate a sufficient rent over mortgage payment surplus and the vast majority of lenders adhere to it.  The equation they use is 5.5% x 145%, or 125% in certain circumstances. 

Let’s work that out on your property: 

75% of your £325k value is £243,750 - so you can only really take out another £16,750. £243,750 x 5.5% = £13,406 (the annual rental) divided by 12 gives you a monthly rental of = £1,117.18 

Now multiply that by 145% and you get £1,619.92 - so based on that your rent would have to be £469.92 higher than it currently is to get that £16,750 out. 

Use the 125% model and you get £1,396.47 - so your rent would have to be £246.47 higher than it currently is to get that £16,750 out. 

I’m guessing you took out your mortgage before this model was invoked, because on this basis, you wouldn't even get the £227,000 mortgage you currently have.

There are a minority of lenders who operate outside of the PRA so can side step this, but you wouldn't expect them to have market leading products.

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