In 2007 the European Commission adopted a White Paper on the Integration of European Mortgage Markets. The aim was to integrate the mortgage markets across the European Union so that individuals buying property in multiple member states would do so under a broadly similar legislative and regulatory framework. The idea was good in principle. It meant, for example, that someone from Germany would be able to buy property in France without needing specialist knowledge of the French legal system and that they would be safeguarded against accidentally falling foul of any unusual regulations imposed on French mortgage products.
These proposals became more politically urgent when the financial crisis hit Europe. In response to the crisis, and in the context of efforts to ensure an efficient and competitive single market, the EC brought forward measures on responsible lending and borrowing, including a reliable framework on credit intermediaries. However, when it introduced the legislation into the European Parliament, the EC had underestimated the diverse nature of Europe’s mortgage markets as many member states have specialised and extremely nuanced mortgage products, such as buy-to-let mortgages in the UK and Ireland.
Therefore, while the concept of harmonising the mortgage market across Europe was a positive and welcome step for property owners, the mortgage directive – officially known as the Credit Agreements Related to Residential Property Directive – attempted to create a single regulatory framework that would govern all mortgages within the EU. Had the directive passed into law in its original form it would have had fundamental and far-reaching consequences on mortgage markets in many member states and would have been extremely detrimental to the large number of landlords with buy-to-let portfolios in the UK.
It is important to remember that the UK’s private-rented sector is made up of a large number of individual landlords, with many owning two or three properties. It is heavily dependent on mortgage finance, with buy-to-let mortgages outstanding on approximately 38 per cent of all private rented properties in the UK. In its original form the directive would have had a devastating effect on the availability of suitable and sustainable buy-to-let finance.
When the directive was first published, the key issue for landlords was the credit worthiness provisions – the rules governing when a mortgage lender may, by law, offer mortgage credit. Most lenders operating in the UK’s buy-to-let sector base their credit worthiness decisions on a combination of rental income and property value. The landlord’s personal income is irrelevant in the lending decision. However the EC had drafted the directive so that all mortgage applications would require the buyer’s personal circumstances to be taken into consideration. It had even gone so far as to specifically exclude potential rental income from the credit worthiness provisions.
The rental income clause was removed shortly after the European Parliament’s economic and monetary affairs committee began its deliberations on the text of the directive. However it had not fully understood that requiring mortgage companies to take a landlord’s personal income into consideration as part of every lending decision would have rendered the entire concept of the buy-to-let mortgage unlawful.
The directive was designed to protect consumers from the mortgage excesses that had brought about the housing crisis in the US and Europe. But is a person who takes out a buy-to-let mortgage on a property with the sole intent of letting out that property operating in a personal or business capacity? Should this type of economic activity fall into the same class as someone who takes out a residential mortgage to finance the home in which they live? These are two fundamentally different transactions. One is personal to the individual, the other is a business transaction. A residential mortgage is based on the applicant’s personal income, whereas a buy-to-let mortgage is based on the income that can be generated by operating the property as a business venture.
By classing buy-to-let mortgages as business transactions, the UK’s buy-to-let sector would have been unaffected by the directive. However excluding buy-to-let mortgages from the scope of the directive altogether would have left consumers, in particular private rented tenants, less secure and not subject to the same safeguards as the other mortgage products protected by this directive, both in the UK and throughout the EU.
A balancing exercise was required. The UK’s buy-to-let sector has a much lower-risk profile for lenders than other forms of mortgage lending and therefore excluding it from the scope of this directive should not leave the market insecure.
The Council for Mortgage Lenders has kept regular statistics on the market since the mid-1990s. Its research demonstrates that arrears in the buy-to-let sector are much lower than the owner-occupied sector. Indeed Paragon Mortgages, a company that only offers buy-to-let products, reported in May 2011 that during 2010/2011 only 0.75 per cent of its loans were in arrears.
Furthermore while it is still relatively easy for consumers to access 80 per cent and 85 per cent loan-to-value residential mortgages, in the buy-to-let market the norm is much lower. The standard LTV is around 60 per cent which requires landlords to have a significant cash deposit before applying for a buy-to-let mortgage.
It is important to remember that unless a purchaser has an existing residential mortgage, buy-to-let finance will only be available on the standard residential calculator. It cannot be used to bypass the standard multipliers attached to residential mortgages. Indeed in order to obtain buy-to-let finance based on rental income the vast majority of purchasers are demonstrating they are at a low risk of default as they are also repaying a residential mortgage. A person who has a poor history of defaulting on a residential mortgage would not be offered buy-to-let finance.
A buy-to-let mortgage application also requires both a property valuation and a rental assessment. Most lenders will not proceed unless the rental assessment is at least 25 per cent higher than the monthly mortgage repayments. While this provides security for the lenders, it also creates natural safeguards in the sector as a whole. This 25 per cent allows for general maintenance work, the creation of reserve funds, the ability to cover mortgage payments during void periods and profit for the landlord. None of these safeguards are available in normal residential mortgages.
Therefore the various branches of the EU, when reaching agreement on the final text of the directive, needed to safeguard consumers while allowing the continued existence of nuanced mortgage products, such as buy-to-let. It took the pragmatic approach and excluded buy-to-let from the credit worthiness provisions, but kept it within the scope of the directive for everything else. This has ensured that private tenants are safeguarded from unstable speculation by over-leveraged landlords, while still allowing the UK’s buy-to-let sector to thrive on a sustainable footing.
The provisional text of the directive was approved by the European Parliament on Wednesday 11 September 2013 and will be endorsed by the member states early next year.
David Cox is senior policy officer for the National Landlords Association
Key points
Buy-to-let mortgages are outstanding on approximately 38 per cent of all private-rented properties in the UK.
Paragon Mortgages reported in May 2011 that during the previous financial year only 0.75 per cent of its buy-to-let loans were in arrears.
Buy-to-let has been excluded from the credit worthiness provisions but kept it within the scope of the directive.
