If you are thinking about getting a buy-to-let mortgage, you may come across the term interest coverage ratio, or ICR. It sounds complex, but it is quite simple once you know what it means. This guide explains what ICR is, why it matters, and how lenders use it.

Interest coverage ratio definition

The interest coverage ratio is a way of measuring whether your rental income is high enough to cover your mortgage interest payments. Lenders use it to check that you will not struggle to pay your mortgage if things change, such as if interest rates go up or your property sits empty for a while.

In simple terms, ICR compares how much rental income you bring in against how much you need to pay in mortgage interest each month. The higher the ratio, the more comfortable the lender feels about offering you a mortgage.

ICR is mainly used for buy-to-let mortgages. It is one of the key checks a lender will carry out when you apply.

Why is the interest coverage ratio important?

Lenders need to know that your rental income can support your mortgage. They do not just look at whether you can afford the repayments today. They also think about what would happen if the interest rate went up.

For example, if your monthly rental income is only just enough to cover your mortgage payments, even a small rate rise could leave you short. The ICR helps lenders spot this risk before they approve a loan.

ICR also matters because it affects how much you can borrow. If your expected rental income is low compared to the interest costs, a lender may offer you a smaller loan. Understanding ICR can help you plan your finances before you apply.

What is a good interest coverage ratio?

Most buy-to-let lenders look for an ICR of at least 125%. This means your monthly rental income must be at least 125% of your monthly mortgage interest payment. Some lenders set this higher, at 145% or even more.

The required ICR can also depend on your tax situation. If you pay a higher rate of income tax, some lenders will apply a stricter ICR. This is because landlords who pay more tax take home less of their rental income, which leaves less of a buffer to cover mortgage costs.

Here is a rough guide to what different ICR levels mean:

  • Below 125%: Many lenders will not offer a mortgage at this level. You may need to put down a larger deposit or find a property with higher rental income.
  • 125% to 145%: This is acceptable to most standard buy-to-let lenders.
  • Above 145%: A strong ratio that gives you more options and may help you borrow more.

Understanding the interest coverage ratio formula

The interest coverage ratio formula is straightforward. Here is how it works:

ICR = (Annual rental income / Annual mortgage interest) x 100

Let’s look at an example. Say your property rents for £1,500 a month. That is £18,000 a year. Your annual mortgage interest is £12,000.

ICR = (£18,000 / £12,000) x 100 = 150%

In this case, the ICR is 150%. This is above the 125% to 145% threshold that most lenders look for, so it would likely be acceptable.

Keep in mind that lenders sometimes test the ICR using a higher interest rate than the one you will actually pay. This is called a stress test. It checks whether you could still meet the ICR if rates went up. Always ask your lender which rate they use for this calculation.

Interest coverage ratio variations

Not all lenders calculate ICR in exactly the same way. There are a few variations to be aware of.

Gross vs net rental income. Some lenders use your gross rental income (the full amount before any costs). Others use a lower figure to account for things like maintenance, void periods, and letting agent fees. Using a lower income figure makes it harder to meet the ICR threshold.

Stress testing. As mentioned above, many lenders apply a higher notional interest rate when testing your ICR. This rate is often around 5% to 6%, even if your actual mortgage rate is lower. This is to make sure you could cope if rates rise.

Tax band adjustments. Some lenders adjust the ICR based on whether you are a basic or higher rate taxpayer. Higher rate taxpayers may face a stricter threshold, such as 145% instead of 125%.

Portfolio landlords. If you own four or more buy-to-let properties, lenders may look at the ICR across your whole portfolio, not just the single property you are applying for.

Because the rules vary between lenders, it is worth speaking to a mortgage adviser before you apply. They can help you find a lender whose ICR criteria suit your situation.

Final thoughts

The interest coverage ratio is one of the most important checks in the buy-to-let mortgage process. It tells lenders whether your rental income is strong enough to support your mortgage, even if conditions change.

Understanding ICR before you apply can help you choose the right property, set a realistic budget, and avoid problems during your application. If you are unsure how your numbers stack up, a good mortgage adviser can walk you through it.

Whether you are buying your first rental property or expanding your portfolio, a broker can help you find a buy-to-let mortgage that works for you. Pepper Money works with a network of specialist brokers. Find a broker to get started.