The Bank of England has recommended that mortgage lenders become stricter about buy-to-let underwriting rules. To ensure that property investors have the key points they need, we have important information for landlords on the new underwriting rules.
Commercial finance broker CPC Finance has broken down 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 mortgage lenders should be stricter when deciding whether or not to approve a loan.
The PRA’s aim is to ensure that lenders conduct their business in a sensible manner, thereby preventing a loosening in buy-to-let underwriting standards and limiting inappropriate lending and the potential for excessive credit loss.
What is a buy-to-let mortgage?
Mortgages are classed as buy-to-let if 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 will be occupied on the basis of a rental agreement in Great British Pounds.
Affordability tests
Important Information for Landlords on New Underwriting Rules
The PRA has proposed that all lenders use an affordability test when assessing a buy-to-let mortgage contract, either in the form of an interest cover 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 rises. Currently, the standard minimum threshold that lenders work with is 125%.
When assessing the minimum ICR requirements, the PRA recommends that, among other things, lenders give consideration to all costs associated with letting the property, where the landlord is responsible for payment. These include: management and letting fees, Council Tax, service charges, landlord insurance, repairs, void periods, utilities, gas and electrical certificates, license fees, ground rent, and any other associated costs.
Lenders must also take into account any tax liability associated with the property, including the tax relief change coming into force from April 2017.
Personal income
If personal income is being used to support the mortgage, an income affordability test will be used to assess whether that income, in addition to any rental income from the property, is sufficient to support the mortgage payments.
Types of income 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 (for example, school fees), both personal essential expenditure and that related to the property (see above), as well as living costs, must be considered.
In regard to personal income, the lender may obtain details of 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 proposed 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 buy-to-let mortgage term (unless it is fixed for five years), or for the duration of the mortgage contract if shorter than five years.
Even if the projected interest rate indicates that the borrower’s interest rate will be less than 5.5% during the first five years of the mortgage contract, the lender should assume a minimum borrower interest rate of 5.5%. Mortgage providers should also account for a minimum increase of two percentage points in buy-to-let mortgage interest rates, and regard any indication of rises from the Financial Policy Committee, as well as market expectations.
However, landlords must be aware that yesterday, the Bank of England decided to cut interest rates for the first time in seven years: /interest-rate-cut-affect-you/
Who do the new rules apply to?
The new underwriting rules will apply to all buy-to-let mortgages, regardless of whether the borrower is an individual or a limited company. They will also apply to remortgages 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 are considered a portfolio landlord, and lenders will be expected to have a specialist underwriting process in place for these borrowers.
Additionally, 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 new rules, most property investors will likely see a reduction in the amount that they can borrow and will need to find more of their own money to meet the shortfall. As the stress testing calculation will also apply to remortgages, this will limit the amount of capital raised for re-investment from within a landlord’s own portfolio.
Be aware that these measures will affect all buy-to-let landlords and should be taken into account when next talking to a broker or lender about finance.
Keep up with the latest information for landlords at Landlord News.
