The Prudential Regulation Authority (PRA) has announced new lending rules that are to be applied to Buy to Let landlords. The Authority is the arm of the Bank that regulates banks and the financial sector. The rules come after a review of the buy-to-let market in 2015/2016.
The intention behind the rules is to ensure that underwriting standards are upheld in relation to the Buy to Let Market. While the Authority has acknowledged that most lenders already meet its standards, it has found some weaker lending standards do exist. The Bank’s Financial Policy Committee has also warned that levels of lending to landlords have surged and this poses a risk to the property market and financial system.
The new rules issued by the PRA include:
The lender must consider whether the income derived from the property is likely to cover the monthly interest cost of the mortgage (Interest Coverage Ratio Calculation) taking into account rental demand and typical rent levels in the area.
The expected rental income must be verified by a suitably qualified independent valuer independent of the borrower, an automated valuation model or evidence of an existing rental agreement.
The current Interest coverage ratio (ICR) calculation is 125% – the PRA suggest their proposals should not reduce this figure and in fact, may increase it.
The lender can use the borrower’s own financial circumstances (income and capital) to support their ability to afford the mortgage payments, but must carry out an income affordability test. This is similar to affordability tests that personal borrowers are subjected to.
Buy to let borrowers must undergo the stress test for future interest rate rises (‘Interest Rate Affordability Stress Test), in the same way as personal borrowers. The PRA require that the stress test should be a minimum of two percentage points.
Lenders must take into account any tax liability of the property (for example, the changes to mortgage interest tax relief).
Where a buy to let landlord owned four or more mortgaged buy-to-let properties (known as a ‘portfolio landlord’), a specialist underwriting process must be used. Additional information about the borrower’s experience in the buy-to-let market, their full portfolio of properties, any other outstanding mortgages, their personal assets and liabilities including tax liabilities, and historical and future expected cash flows from other properties will be required.
Full details of the rules can be found here.
The Buy to Let market has already suffered this year with a hike on stamp duty for second homes from 1st April – a reform that has contributed to a drop in stamp duty receipts of 2.5%. Landlords have also lost the right to claim mortgage interest tax relief against their rental income – a measure that will be phased in between 2017 and 2020.
The Bank of England revealed that banks had planned to increase its gross lending to buy-to-let borrowers by 20% a year over the coming years. Without new standards, lending policies might have loosened while banks sought new customers. The new measures alone are likely to reduce the number of buy-to-let mortgages approved by 10 to 20 per cent – on top of the effects that the stamp duty land tax hike and reduction in mortgage interest tax relief will have caused.
If you are a buy to let landlord who would like advice or you are considering entering into the buy to let market, get in touch with our property team.