The Bank of England is recommending that lenders become stricter about buy-to-let underwriting. We wanted landlords to have the key points of the consultation all in one place.
A breakdown of the key points of the Prudential Regulation Authority’s underwriting consultation.
In March this year the Bank of England’s Prudential Regulation Authority (PRA) proposed in a consultation that lenders should be stricter when deciding whether or not to provide a loan. Due to end on 29th June, the impact of the consultation could be felt as soon as August.
The PRA’s aim in putting forward this consultation is to ensure that lenders conduct their business in a prudent manner, thereby preventing a loosening in buy-to-let underwriting standards and curtailing inappropriate lending and the potential for excessive credit losses.
So that landlords have the essential information from the consultation, we wanted to draw out the key points and wording property investors should be aware of.
Buy-to-let mortgage definition
Mortgages are being considered UK buy-to-let where at least 40% of the land is used, or is intended to be used, as or in connection with a dwelling and the land subject to mortgage cannot at any time be occupied as a dwelling by the borrower or a related person, and is to be occupied on the basis of a rental agreement in pounds sterling.
Affordability testing
The PRA is proposing all lenders use an affordability test when assessing a buy-to-let mortgage contract in the form of either an interest coverage ratio (ICR) test and/or an income affordability test.
The ICR is the ratio of the expected monthly rental income from the buy-to-let property to the monthly interest payments, which take into account likely future interest rate increases. Currently the standard minimum threshold lenders work with is 125%.
When assessing the minimum ICR requirements, the PRA is recommending that among other things, lenders give consideration to all costs associated with renting out the property where the landlord is responsible for payment. These could include: management and letting fees, council tax, service charge, insurance, repairs, voids, utilities, gas and electrical certificates, licence fee, ground rent and any other costs associated with renting out the property.
They will also need to take into account any tax liability associated with the property (including the tax relief change announced in the Summer Budget 2015).
Personal income
Where personal income is being used to support the rent, an income affordability test will be used to assess whether that income, in addition to any income from the property, is sufficient to support the mortgage payments.
Types of income will include: employment, rental income on all properties, pensions, savings and investments.
In terms of outgoings to deduct from income, the borrower’s income tax, national insurance payments, credit commitments such as loans or credit cards, tax liability associated with financing the property, committed expenditure (eg. school fees), both personal essential expenditure and that related to the property (see above), as well as living costs, will need to be considered.
With regards to personal income, a firm may obtain details of the actual expenditure. Alternatively, it may use statistical data or other modelled data appropriate to the composition of the borrower’s household.
Interest rate rises
The PRA proposes that in all affordability testing lenders should take into account likely interest rate rises over a minimum period of five years from the expected start date of the term of the buy-to-let mortgage contract (unless it is fixed for five years), or for the duration of the mortgage contract if shorter than five years.
Even if the interest rate determined above indicates that the borrower’s interest rate will be less than 5.5% during the first five years of the buy-to-let mortgage contract, the firm should assume a minimum borrower interest rate of 5.5%. Lenders should also account for a minimum increase of 2 percentage points in buy-to-let mortgage interest rates and have regard to any indication of rises from the Financial Policy Committee, as well as market expectations.
What the new standards apply to
The new standards will apply to all buy-to-let mortgages regardless of whether the borrower is an individual or limited company. They will apply with re-mortgages larger than the original loan but not where there is no additional borrowing beyond the amount currently outstanding under the existing buy-to-let contract.
Portfolio landlords
If a landlord has four or more mortgaged properties they will be considered a portfolio landlord and lenders will be expected to have a specialist underwriting process in place for them.
As an additional point, the SME supporting factor (the reduction of the capital requirements on loans to SMEs by 24%) should not be applied to loans where a buy-to-let business is the intended purpose.
As a result of these measures most investors will likely be able to borrow less and need to find more of their own money to meet that shortfall when investing. As the stress testing calculation will also apply to re-mortgages, this will limit the amount of capital raise for re-investment from within an investor’s own portfolio. These measures are something that will affect all property investors and should be taken into account when next talking to a broker or a lender about finance.