Brokers are being warned about the potential consequences of recommending a pay-rate buy-to-let mortgage to landlord clients in light of expected changes from the Prudential Regulation Authority.
Simon Bayley, commercial director at Foundation Home Loans, said buy-to-let lenders offering pay-rate products – the pay rate being the initial or reversionary rate used by a lender to calculate rental cover – on fixed or lifetime trackers are potentially creating the next affordability bubble.
Mr Bayley said: “Lifetime trackers or shorter-term fixed products on a pay-rate basis can be proposed to maximise the loan amount, or to fit on affordability.”
“However, when landlords come to refinancing, they will have to fulfil the PRA [Prudential Regulation Authority] criteria of a minimum stress rate of 5.5 per cent, not taking into account any future interest rate increases that could leave them as mortgage prisoners unable to refinance away from their current lender.”
[pull out stat - PRA’s criteria 5.5 per cent stress test]
At the end of March, the Bank of England’s regulatory arm published a consultation proposing that minimum standards firms should meet when underwriting buy-to-let contracts.
Mr Bayley pointed out if these are taken forward, advisers will need to ensure they have discussed the implications of pay-rate mortgages with their clients.
We have already seen in the owner occupier market how a tightening in criteria can limit the options for those shopping around at a later date. David HollingworthRecommending a pay-rate mortgage makes sense to landlords who want to maximise the amount they are able to borrow because lenders can still use the pay rate in the calculation, he explained, before cautioning that when they wish to refinance many will find that instead of using a pay rate, they must now face a stress test at a minimum of 5.5 per cent, “which could very well make any chance of refinancing impossible”.
“Making sure they are fully aware of how pay-rate mortgages might be attractive at the outset because of the uplift they provide, but how they could leave the landlord stranded further down the line, will be vital in terms of offering the right advice.”
Mr Bayley added that further consideration should also be given to an eventual increase in interest rates, and the effect this might have on the yields of those landlords who are unable to refinance and are stuck on a lender’s standard variable rate.
Adviser view
David Hollingworth, associate director of communications for London & Country Mortgages, said last week’s criteria changes from The Mortgage Works are a hint of some of the changes that could be coming for rental calculations.
Mr Hollingworth said: “The PRA consultation puts longer-term affordability at its heart, and it is clear on its view that a minimum stress rate of 5.5 per cent would be appropriate.
“That is likely to result in more changes from lenders generally, and those seeking to push their borrowing to the max should bear in mind that it could be harder to refinance if rental income does not increase over time.
“We have already seen in the owner-occupier market how a tightening in criteria can limit the options for those shopping around at a later date.”
peter.walker@ft.com
