Following the announcements made in the Summer Budget of 2015, and the Prudential Regulation Authority’s (PRA) Supervisory Statement 13/16. As of 1st January, we have now seen most of the Buy to Let Mortgage Lenders implement the required changes to their lending criteria, mainly in the form of stricter affordability tests including Interest Cover Ratio’s to protect against the impact of recent Tax Changes and a stress test on interest rate rises.
The regulatory changes have come into effect for new Purchases and Capital Raising – remortgage buy to let properties remain unaffected.
Other loans, such as, Holiday lets, bridging loans, and corporate lending are exempt from the underwriting standards.
So what does it all really mean?
Tougher Interest Cover Ratio’s
Lenders looking at rental cover requirements must now demonstrate that they are taking into account all the management costs associated with the property along with the borrower’s tax position. With the reduction in mortgage interest relief for high and higher rate tax payers starting to take effect, the decision has been that the standard 125% cover previously used is insufficient. There is now a general assumption that all borrowers are high rate tax payers and only the most sophisticated lenders have the mechanisms to apply lower stress tests for basic rate tax payers. Over the last few months we have seen the majority of lenders gradually increasing stress tests for personal borrowers from 125% to 145% whilst maintaining stress rates at 125% for those borrowing via a corporate vehicle (i.e. SPV limited company).
More probing background checks
Those lenders which also consider personal income to top up rental coverage are also now required to undertake stronger assessments of income and expenditure to ensure that there is sufficient surplus income to meet the requirements.
5% notional rate longer sufficient
There has been much discussion also on the interest rate lenders should use when stressing the rental coverage. Previously, 125% at 5% used to be good enough but with the reduction in mortgage interest relief and the effect on landlord income. The general stance now taken by lenders is that a minimum rate of 5.5% should be used (or 2% above the pay rate if higher). The supervisory note stated that lenders must take into account the market expectation in interest rates during the first five years. Subsequently for 5 – 10 years fixed rates lenders seem to be stressing mortgages at the Pay Rate, which would still seem to be the best way of managing any interest rate uncertainty and I would therefore expect the trend towards these products to continue. However, lenders will need to bear in mind any refinancing risk after the five year period and if we do see lenders trying to get around rules with a flux of low five year products, I would expect the PRA to review.
More robust underwriting for “Portfolio Landlords”
In addition to the affordability checks, lenders are being asked to have robust underwriting processes in place for “Portfolio Landlords” the definition of which, is someone with four or more mortgaged properties.
Going forward landlords with large portfolios will be subject to further affordability checks. Lenders will look to stress background portfolios against new rules to ensure that landlords are not over committed and it is unlikely that they will rely on the borrower’s spreadsheet for details around rental income versus mortgage payments. All portfolio landlords should expect to be asked for bank statements, tax returns, SA302s, ASTs, rental accounts and potentially income and expenditure statements when applying for finance.
Lenders have until September 2017 to ensure that they have robust underwriting processes in place for portfolio landlords but the majority of new rules have now been put in place.
Following the lenders tightening on Rental Income Affordability, especially for personal borrowing, I expect we will see the following:
- We will see a continued move towards landlords using limited company structures to purchase investment properties.
- Stronger dependency on Mortgage Brokers to provide the right advice.
- Landlords will be pushed towards five year fixed rates to maximise gearing.
- Landlords used to dealing with mainstream vanilla lenders will need to provide more comprehensive supporting documentation in the future
- New lenders coming to market will need to ensure that they have the appropriate underwriting skills to meet new standards.
- Landlords will continue to seek higher yielding properties. Rents on standard properties may also rise.
At Insight Private Finance we specialise in working with landlords helping them to develop their investment strategies and guiding them through the lenders’ various credit policies and all of our consultants are geared up to handle the most complex of transactions. If you have any queries please do not hesitate to get in touch.
Joseph Zammit BA (Hons)
Senior Mortgage and Protection Consultant
Tel: 01279 709300
Mob: 07939 230830