The Prudential Regulation Authority has set out its plans to strengthen buy-to-let underwriting standards, including a minimum level of stress testing to ensure loans remain affordable when rates rise.
The consultation was published earlier today (29 March) and closes on 29 June.
It stated the buy-to-let market is characterised by floating, or relatively short-term fixed mortgage rates, typically on an interest-only basis, which increase sensitivity to changes in interest rates.
Consequently, the PRA said, when assessing affordability in respect of a potential buy-to-let borrower, firms should take account of likely future interest rate increases.
These should be considered over a minimum period of five years from the expected start of the mortgage contract’s term, unless the interest rate is fixed for a period of five years or more from that time, or for the duration of the buy-to-let mortgage contract if less than five years.
In coming to a view of likely future interest rates, the PRA expects firms to have regard to:
• Market expectations;
• A minimum increase of two percentage points in buy-to-let mortgage interest rates; and
• Any prevailing Financial Policy Committee recommendation or direction on the appropriate interest rate stress tests for buy-to-let lending.
Its proposals also included a section on affordability testing, noting rental income is an important factor when determining the ability of buy-to-let landlords to service their debt. Accordingly, a widespread market practice is to use the mortgage’s interest coverage ratio (ICR) in assessing affordability.
The PRA is therefore proposing that all firms use an affordability test when assessing a buy-to-let mortgage contract in the form of either an ICR test and/or an income affordability test, where firms take account of the borrower’s personal income to support the mortgage payment.
A standard set of variables should be reflected within the ICR test and the income affordability test, the consultation said. To ensure firms are being prudent in their affordability assessment, the PRA is also proposing firms give consideration to:
• 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.
The PRA is not at this time proposing supervisory guidance with respect to specific loan-to-value standards, however it does expect firms to have appropriate controls in place to monitor, manage and mitigate the risks of higher LTV lending.
Elsewhere in the document, the PRA said it is seeking to establish a standard definition of what constitutes a ‘portfolio landlord’, suggesting this would be met where they have four or more mortgaged buy-to-let properties across all lenders in aggregate.
It expects firms conducting lending to portfolio landlords do so according to a specialist underwriting process, which accounts for the complex nature of the borrower and their portfolio of properties.
Finally, on risk management, the PRA made clear it wanted lenders to have “robust” systems and controls specifically tailored to their buy-to-let portfolios, including risk appetite statements governing how core risks will be identified, mitigated and managed.
It noted the buy-to-let market is dominated by lending originated through intermediaries. “There is some concern that firms with weaker underwriting standards may be adversely selected which could result in a concentration of a particular risk on individual firms’ balance sheets,” it said.
“Consequently, the PRA expects firms to have appropriate oversight and monitoring capabilities with respect to their intermediary business.”
Andrew Montlake, director at Coreco Mortgage Brokers, welcomed a minimum set of requirements for lenders when assessing buy-to-let applications.
But he raised fears the end result would be to drive more landlords out of the market and cause some of the very issues the Bank of England are trying to avoid.
“This set of guidelines will have an effect in dampening the growth of the buy-to-let market, but has stopped short of an all-out assault,” he said.
He pointed out that the stress test of at least 2 per cent above current rates in the first five years of the loan will have more of an effect in areas such as London, where this effectively limits loans on more expensive, lower yielding properties to around the 60 per cent LTV.
Adrian Anderson, director of mortgage broker Anderson Harris, said it was encouraging existing landlords and their investments will not be unfairly hit by any proposed changes.
“The proposals will not apply to those remortgaging existing buy-to-lets as long as landlords do not want to take on any extra borrowing. It is likely that many will stick with their existing investments and not add to them, unless the argument for doing so is truly compelling.
‘We don’t expect a mass exodus from buy-to-let but whether it will be such an attractive investment in the future for new landlords remains to be seen. It will certainly be harder to get a buy-to-let mortgage and while the Bank of England is not imposing a maximum loan-to-value cap, there will be a downwards pressure on LTVs, making buy-to-let the preserve of wealthier landlords.”
peter.walker@ft.com
