Tighter rules for new Landlords

3 April 2016

Landlords face tighter lending rules

Already on the back foot following tax changes which will impact on potential profits those landlords who need to borrow to finance their investments will face another obstacle following a decision by the Bank of England’s regulation arm, the Prudential Regulation Authority (PRA) to introduce tighter rules on buy to let borrowing.

The changes under consultation include tighter affordability and repayment assessments amid warnings that increasing levels of lending pose a risk to the property market.

Although this looks like more bad news for landlords any resulting pause in price increases resulting from the tighter rules might actually be good news for financially prudent investors either looking to join the buy to let market or existing landlords seeking to expand their portfolios.

Here is a breakdown of the proposals and how they could affect investor landlords:

Affordability testing

The PRA wants lenders to make income checks tighter for buy-to-let investors to reduce the probability of defaulting on a loan especially when interest rates rise.

Currently, rental income and capital growth (the increasing value of the property) which are both important factors are taken into consideration by underwriters.

The new proposals could see more affordability testing for investors in the form of:

  • an interest coverage ratio (ICR) – a measure of how the investor can repay the debt before interest and taxes, and/or
  • an income affordability test – where lenders take account of the borrower’s personal income

The proposals say firms should calculate the impact of rising interest rates over a minimum of five years.

These measures would assess 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
  • the borrower’s income tax, national insurance payments, credit commitments, committed expenditure, essential expenditure and living costs (where personal income is being used to support the rent).
  • clarification regarding application of the small and medium enterprises (SME) supporting factor on buy-to-let mortgages.

Interest rate affordability stress test

The PRA says that because the buy-to-let market is characterised by floating, or relatively short-term fixed mortgage rates usually on an interest-only basis buy-to-let lending is particularly sensitive to changes in interest rates. It therefore proposes measures to assess the investor’s ability to cope with rising interest rates.

It proposes that lenders:

  • consider the likely future interest rates over a minimum of five years from the start of the contract or for the duration of the contract if less than five years.
  • carry out interest ‘stress tests’ based on market expectations and a calculation based on a minimum increase of two percentage points and any Financial Policy Committee (FPC) direction or recommendation.
  • Assume a minimum borrower interest rate of 5.5% even if the stress tests indicate a lower rate.

Portfolio landlords

Portfolio landlords will be defined as those who have four or more buy-to-let properties.

Data shows that there is an increase in observed arrears rates of landlords with buy-to-let portfolios of four or more, the PRA said.

The PRA proposes:

  • Investors with four 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.

The consultation on these proposals for tighter rules on mortgage lending closes on Wednesday, June 29.

About Source

Source specialises in helping new and existing landlords find the best buy to let investment opportunities. Whether you are a first time investor or already have a portfolio of properties that you are looking to expand or dispose of we can provide expert assistance.  For more information visit source.investment.