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How does the interest coverage ratio work in the UK Mortgage Business?

How does the interest coverage ratio work in the UK Mortgage Business?

A crucial financial indicator used to assess a borrower’s capacity to pay interest commitments is the Interest Coverage Ratio (ICR). In particular, when seen in the context of the property investment in the United Kingdom, it acts as a significant predictor of financial soundness and creditworthiness of an asset being financed. Lenders evaluate the risk involved with a property’s debt using LTV (Loan To Value) and ICR (Interest Coverage Ratio) among other underwriting aspects. But, how does interest coverage ratio work in the UK mortgage business is a question by many investors. So we have a small guide to give you an understanding about the concept. So, here you go!

Interest Coverage Ratio Definition and Calculation

A financial indicator called the Interest Coverage Ratio (ICR) evaluates a borrower’s capacity to pay its interest payments. It offers information about whether a property can earn enough revenue to pay the interest costs it incurs on its debt if the borrower defaults.

The Interest Coverage Ratio is calculated using the following formula:

Let’s understand how ICR works for lenders.

Lenders work backwards for evaluating ICR. Say, a property earns a monthly rent of £1300 and the Lender requires an ICR of 1.3. This means that the maximum monthly payment acceptable by the Lender will be £1000. Therefore, one can calculate how much they can borrow on the property within the acceptable monthly payment threshold with various interest rates .

Consider a property that brings in £1300 per month in rent. The maximum monthly payment should be £1000 in order to meet the lender's criteria which call for the ICR to be at least 1.3.

The greatest amount that might be borrowed at a 10% interest rate is £120,000 (Monthly Rent x 12 / Interest Rate). This computation takes the ICR into account and makes sure the monthly interest payment stays within the permitted range for the lender.

If you are buying this property for £240,000, the LTV you are going to get is 50% even though the lender’s maximum LTV may be 75% or 80%.

The maximum borrowing capacity doubles to £240,000 if the interest rate drops to 5%. However, the lender may not lend the entire £240,000 if you are purchasing it for £240,000 as lenders do not lend 100% LTV. Subject to any maximum Loan-to-Value (LTV) limits in effect, it's vital to remember that lenders often base their loan limits on the lower of the LTV or ICR.

Therefore, it's important to calculate the ICR in addition to taking the LTV alone into consideration when applying for real estate financing through Novyy or any other lending company. By doing this, you can research techniques to maximise your profits and make better decisions regarding your assets.

In conclusion, those seeking to buy properties in the UK and seeking to finance them via  or any other lending enterprise must calculate ICR and not depend on LTV alone.

Don't pass up the opportunity to maximise your real estate investment. Utilise Novyy’s team of experts' knowledge and experience to determine your borrowing capacity depending on rent and interest rates. Start today on the path to a profitable property investment.

 

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