In this brief guide, we are going to discuss what a mortgage stress test is and how you can ensure you pass your mortgage stress test

What is a mortgage stress test?

A mortgage stress test is when a mortgage lender evaluates how lifestyle changes, the loss of your job or interest rate rises could affect your ability to repay your mortgage.

In the past, most mortgage lenders simply looked at an income multiple to determine your ability to repay a mortgage. These days an income multiple is only guidance on the maximum a mortgage lender may be willing to lend you.

Mortgage stress test for buy to let mortgages

When performing a mortgage stress test for a buy to let mortgage, the buy to let mortgage lender will mostly be interested in the rental coverage ration.

The rental coverage ratio is the first requirement most buy to let mortgage lender use to ensure that borrowers(landlords) can continue affording to repay their buy to let mortgages in the event of any interest rate rises or missed rental payments from their tenants.

Most buy to let mortgage lenders may request a rental coverage of 125% but this may be increased significantly based on your circumstances.

When performing a mortgage stress test for a buy to let mortgage, the buy to let mortgage lender will take into account:

  • The borrower’s income
  • The borrower’s circumstances
  • The rental income
  • The borrower’s current mortgage portfolio for landlords who own more than 4 mortgaged properties

The mortgage lender will also apply a mortgage stress test of a 5.5% increase for the first five years of the buy to let mortgage.

Mortgage stress test for residential mortgages

The mortgage stress for residential mortgages mostly involves the mortgage lender looking to see if the borrower will be able to continue repaying the mortgage comfortably from their monthly disposable income in the event of an interest rate rise.

Different mortgage lenders will use different percentile point increases when performing a mortgage stress test but this may be based on the type of mortgage or your circumstances as a borrower.

If you are self-employed you may find that the requirements are much higher. 

The same can be said for someone with bad credit.

A mortgage lender can then determine what income multiple they will give you based on the results of your mortgage stress test.

In fact, the mortgage stress test starts at the point in which the mortgage lender evaluates your mortgage affordability.

The mortgage lender will group your transactions into basic expenses, lifestyle expenses and committed expenses in order to work out what your true mortgage affordability is.

Lifestyle expenses(gyms, restaurants, holidays etc) are expenses which you could easily cut out in order to save more money for your committed expenses such as your monthly mortgage repayments or other credit repayments.

By conducting a mortgage stress test the mortgage lender will be satisfied that you can repay the mortgage now but also in the event of any changes in the future.

A mortgage stress test is part of the mortgage lenders internal risk scoring and as such, you may not be privy to this information.

Using an interest rate rise during the mortgage stress test was introduced by the FCA in 2014 after the mortgage market review.

The FCA asked mortgage lenders to consider if borrowers could still afford their monthly mortgage repayments if at any point over the first five years the mortgage rate was to rise by 3% higher than the mortgage rate at the origin of the mortgage.

This will also be the case if your mortgage rate changes after a fixed introductory period.

How to pass a mortgage stress test

To pass a mortgage stress test you will want to do everything to increase your mortgage affordability before you apply for a mortgage

You can increase your chances of passing a mortgage stress test by:

Using a government scheme

Cutting down on your expense

Increasing your income

Shopping for a cheaper home

Increasing rent (if you are a Buy to let landlord)

Using a government scheme

You can use a government scheme to increase your mortgage deposit and hence it will reduce the amount of mortgage you are borrowing and your monthly mortgage repayment.

This can increase the likelihood of you passing a mortgage stress test.

Some of the Government schemes you may be able to use include:

  • Lifetime ISA– gives you a government bonus of £1,000 if you save the maximum £4,000 a year.
  • Help to buy ISA– gives a maximum bonus us £3,000 if you save the maximum allowed of £12,000. Before you get either you should consider which is better. Lifetime ISA vs Help to buy ISA.
  • Help to buy equity loan- gives you up to 40% as a 5-year interest-free equity loan. You begin to pay interest at 1.75 % after the fifth year and 1% plus RPI for every year thereafter.
  • Shared ownership– You can buy between 25% to 75% of the property initially with a shared ownership mortgage and then buy more using a staircasing mortgage.
  • Armed forces help to buy– similar to the help to buy equity loan but specific for the armed forces personnel giving them an increased chance of acceptance.
  • Rent to buy– This is the right to buy scheme on which this guide is currently discussing. A different marketing name is just used. Watch out for this when shopping to avoid missing out on eligible properties due to confusion.
  • Right to buy– allows you to buy your home at a discount price.
  • Preserved right to buy- same as above.
  • Right to acquire- same as above.

Depending on where you live, you may also be able to take advantage of home buying schemes provided by your local council. Example: In Norwich, the local councils provide the Norwich home options scheme.

Cutting down on your expense

You can increase the probability of passing the mortgage stress test by cutting down on your expenses.

By cutting down on your expenses you will increase your monthly disposable income and be able to afford any increase in your monthly mortgage repayments.

Increasing your income

You could increase your income by getting a side job or taking on more hours. This could help you increase your disposable income and the likelihood of you passing the mortgage stress test.

Shopping for a cheaper home

You could also shop for a much cheaper home and by default require a smaller mortgage. This could make it much easier for you to pass a mortgage stress test.

Increasing rent (if you are a Buy to let landlord)

If you are a buy to let landlord then the obvious thing you can do to increase your chances of passing a buy to let mortgage test is increasing the rent charged on your property.

Interest rate rise calculator

You can use an interest rate rise calculator to see if you will be able to afford your monthly mortgage repayments if interest rates rose.

Using a mortgage broker

You may want to consider using an independent mortgage broker to get a mortgage.

Mortgage brokers are important as they can access mortgage products from across the whole of the market in some cases.

This could be over 11,000 mortgage products. This may have some advantages rather than going directly to a mortgage lender.

A mortgage broker will look to understand your financial circumstances and then provide recommendations on which mortgage products may be suitable for you based on your mortgage affordability.

After giving you these mortgage recommendations, most mortgage brokers will seek your consent to apply for a mortgage in principle. 

This will allow you to shop for your home easier as more estate agents and sellers may take you seriously or it will give you confidence that your mortgage is indeed a possibility before you make a full mortgage application. 

Once you have found a home you want to buy and are satisfied with the mortgage offer for your mortgage then the mortgage broker will then look to get you a mortgage offer.

This will come with a key facts illustration document which details out the features of your mortgage including how much you will pay per month, if there are any limits such as early repayment fees, or annual overpayment limits.

If you are happy with everything you can then go on to secure your mortgage with the help of a conveyancer.

Your conveyancer will manage the legal searches on the property to ensure there aren’t any issues with it.

They will oversee the sales agreement to ensure it is in your best interest, they will manage the transfer of mortgage funds, exchange contracts with the seller or their conveyancer and set a completion date with the seller or their conveyancer.

In this brief guide, we discussed what a mortgage stress test is and how you can ensure you pass your mortgage stress test.

If you have any questions or comments please let us know.

John Bate

John has 22 years of experience in financial services. This spans across financial research, financial services (As a qualified mortgage broker and underwriter), financial trading and sales at global investment banks. While working as a publishing research analyst, he covered European bank credit and advised institutional clients on investment strategies at both JP Morgan and Societe Generale. John has passed all three levels of the CFA (Chartered Financial Analyst) programme.