New changes to buy to let mortgages
New underwriting rules for Buy to Let mortgages as dictated by the Bank of England’s regulation arm, the Prudential Regulation Authority (PRA), will begin to be phased in over the coming months meaning landlords and investors are in a hurry to secure their funding now as the lending landscape is set to change.
Buy to Let changes: So what has happened, what has changed?
The Bank of England sees buy to let as a potential risk. It’s Financial Stability Report which was published in December last year highlighted the potential knock on risk to the UK economy should interest rates rise. It noted that those with buy to let mortgages may be more sensitive than owner occupiers to these rises and that these rises could ultimately prompt investors to sell their properties which in turn could exacerbate any downturn in house prices that may occur. Consequently HM Treasury has given powers to the Financial Policy Committee to intervene in the buy to let market.
Between December last year and March this year the PRA undertook a review of the underwriting standards in the buy to let market. It assessed a total of 31 firms which account for over 90% of the market.
It raised concerns that Lenders may relax underwriting standards to meet their buy to let growth plans, and has identified a need for ‘micro-prudential action’. In its consultation paper – Underwriting Standards for Buy-to-Let Mortgage Contracts – it outlines its proposals which will see tighter affordability checks, bringing buy to let mortgages more in line with residential mortgages.
Buy to Let changes: What is proposed?:-
- Interest rate affordability stress tests
Buy to let mortgages are generally on floating, or relatively short-term fixed rates usually on an interest-only basis.
The PRA says that this makes buy to let lending particularly sensitive to changes in interest rates and proposes measures to assess the investor’s ability to cope with rising interest rates.
It proposes that lenders:-
- consider likely future interest rates over a minimum of 5 years from the start of the contract or for the duration of the contract if less than 5 years.
- carry out interest ‘stress tests’ based on market expectations and a calculation based on a minimum increase of 2% to ensure that borrowers can continue to afford their mortgage repayments.
- assume a minimum borrower interest rate of 5.5% even if the stress tests indicate a lower rate.
- Tighter income coverage ratio (ICR) tests
The ICR is a test designed to ensure that the borrower’s income is sufficiently higher than their monthly outgoings. It will take the higher tax rates which come into affect in 2017 into account now, as well as all other costs for which the landlord is responsible. Until now this has largely been based on the rental income covering 125% of the monthly mortgage interest payment. However the new tests will go further and will assess other variables including:
- all costs associated with renting out the property where the landlord is responsible for payment;
- any tax liability associated with the property; and
- where personal income is being used to support the rent, the borrower’s income tax, national insurance payments, credit commitments, committed expenditure, essential expenditure and living costs.
- More detailed underwriting criteria for portfolio landlords
Research by the PRA indicates that there is an increase in arrears rates of landlords with buy to let portfolios of 4 or more properties. Lenders will be required to apply stricter and more detailed underwriting processes to this category of investor.
The PRA proposes:
- Investors with 4 or more properties would be considered a portfolio landlord.
- Firms should introduce a special underwriting process for portfolio landlords that accounts for the complex nature of the borrower and their properties.
- Firms should also have robust risk management, systems and controls in place specifically tailored for buy-to-let properties, it is proposed.
What is the outcome of these changes for Landlords?
Ultimately, once implemented, buy to let changes will see a reduction in the total amount that landlords can borrow and lending more difficult to obtain. More immediately the imminent changes will stimulate more activity in the BTL sector as landlords and investors seek to capitalise on opportunities now, while the current lending landscape is still favourable.
However, Lenders will begin reacting soon. Recently Nationwide Building Society has introduced restrictions on buy to let lending and has increased it’s income coverage ratio to 145%. Other Lenders are expected to follow their example.
How should Landlords react
There is no avoiding these buy to let changes and so it is important to stay ahead of them and get your finances in order now. Post the implementation it will be even more important to consult an industry professional as navigating the new lending policies and securing the appropriate buy to let mortgage will be more time consuming and difficult.
Please be aware that by clicking on to the above links you are leaving Oakmead Finance Ltd’s website. Please note that Oakmead Finance is not responsible for the accuracy of the information contained within the linked site(s) accessible from this page.