Yield, cash flow and ROI explained
- Gross yield is annual rent divided by the purchase price. It's useful for comparing areas quickly.
- Net yield takes off running costs (agent fees, maintenance, insurance, service charges and empty periods) but not mortgage costs.
- Cash flow is what's left each month after running costs and mortgage payments, before tax.
- Cash return on investment is annual cash flow divided by the cash you put in. It ignores capital growth.
The rental stress test
Buy-to-let lenders size the loan on rent, not your salary. They check the interest cover ratio (ICR): annual rent divided by annual interest at a stressed rate, often around 5.5% or the product rate plus a margin. Typical minimums are125% for basic-rate taxpayers and limited companies, and 145% for higher-rate taxpayers. Five-year fixed rates are often stressed at the pay rate, which can let you borrow more.
Section 24 and tax
Individual landlords can't deduct mortgage interest as an expense. Instead they get a basic-rate (20%) tax credit on the interest. If you're a higher- or additional-rate taxpayer, your tax bill can be much higher than the cash flow suggests, and the extra rental profit can even push you into a higher band. Many landlords look at buying through a limited company, which has its own costs and trade-offs. Take advice from a qualified tax adviser. Remember the compliance costs of letting too.