Buy-to-let: Laverne Hadaway considers the likely effect of new underwriting standards on one of the mortgage market’s most popular sectors
Seeking an indication of just how strong the buy-to-let market has been in recent years? Look no further than the 2016 Iress Mortgage Efficiency Survey released last month. It showed that buy-to-let borrowing enjoyed by far the strongest growth in 2015/16 compared with other mortgage sectors: it grew 49 per cent over a 12-month period and by 213 per cent over the past five years.
By contrast, the survey found that other sectors had seen a much lower rate of growth; mortgages for first-time buyers, for example, grew by only 0.7 per cent, while residential loans to homemovers fell by 5.6 per cent over the same 12-month period.
No wonder the Prudential Regulatory Authority (PRA) has pressed ahead with plans to curb signs of over-enthusiasm. In September, it confirmed the introduction of new rules on lenders’ underwriting standards, first set out in a consultation paper earlier this year.
Fearing that loans which are affordable in the current low interest rate environment would quickly become unaffordable once rates rise, the PRA has tightened affordability standards, which encompass stress testing, income coverage ratios (ICRs), and income affordability testing.
Affordability
An affordability test will take into account all of the costs associated with renting out a property, such as management and letting fees, insurance, repairs and tax liabilities; there is also a test around personal income in cases where this is taken into account; it will consider income tax, national insurance, credit commitments, committed and essential expenditure and living costs.
Loans will be stress-tested using a 5.5 per cent rate or the pay rate plus 2 per cent; whichever is higher, for the first five years of the loan, unless it is fixed for at least five years. This applies even where there is an indication that the borrower’s interest rate will be less than 5.5 per cent.
An ICR test, meanwhile, will ensure that the rental income is sufficient to support the mortgage payment, again taking account of all costs. The current ICR minimum threshold is 125 per cent – a figure expected to increase rather than decrease in light of the new rules.
The PRA has given a formal definition of a portfolio landlord, defining the term as a borrower “with four or more distinct mortgaged buy-to-let properties”, describing lending to portfolio landlords as “inherently more complex” given cash flows, costs and potential risks of property and geographic concentrations, and is calling for a specialist underwriting approach.
On top of this, lenders have to draw up a written policy differentiating between lending to portfolio landlords and underwriting for BTL lending. ICR tests and interest rate stress tests come into force on January 1, 2017, while the rest of the requirements will be implemented by September 30, 2017.
The regulations are clearly designed to put an end to the short-term interest-only deals that have dominated the sector. The Bank of England believes that in the event of a rate rise, buy-to-let borrowers could rush to sell, triggering a collapse in the housing market and testing the resilience of the banking system.
