In March this year the Prudential Regulatory Authority unveiled a consultation paper looking at the underwriting standards of buy to let mortgage lenders. This was due to concerns that the rapid growth in the buy to let market could represent a threat to financial stability, if lenders failed to apply appropriate lending standards.
What do the new rules say?
Currently most buy to let lenders will want to see that a property will generate an adequate level of rental income to cover the mortgage interest by a certain margin. That typically translated into lenders wanting 125% coverage of the mortgage interest, often calculated at a higher notional interest rate of say 5%, not the mortgage rate.
The new guidelines set out the expectation for lenders to take two important aspects into account.
Rather than simply seek a basic coverage of mortgage interest, lenders will be expected to account for the broader affordability. That could mean taking account of management fees, council tax, repairs, voids and other costs associated with the renting out of the property. Importantly it should also take account of any tax liability, which will increase for higher rate tax payers from April, as tax relief on mortgage interest is gradually eroded.
In addition, lenders will need to allow for future interest rate movement over the next five years, unless the mortgage is fixed for 5 years or more.
The PRA stipulates that it expects firms to take account of market expectation but at the very least apply a minimum increase of 2%.
Even if that is expected to be less than 5.5% during the 5 years the lender should assume a minimum borrower interest rate of 5.5%.
What does this mean for landlords?
Although many lenders have already made some changes to rental income coverage requirements there's likely to be more on the way.
A number of lenders have already increased their rental requirement from 125% to 145% and hiked the stress rate as well in some cases. However, many are still using 5%, which will surely need to increase given the new ruling.
That means that the same level of rental income will no longer support as big a mortgage as earlier in the year. For example, a monthly rental income of £750 would support the following:-
· 125% coverage at 5% could support a £144,000 mortgage.
· The change to a 5.5% stress rate at 125% coverage brings that down to £130,909
· Additional tightening to 145% coverage at 5.5% would mean a mortgage of only £112,850
Lenders will be able to use personal income to supplement borrowing but a detailed affordability assessment will need to be conducted, to ensure that there is spare disposable income after commitments.
Any other new requirements?
Portfolios will be defined as a holding of four or more properties and the PRA will expect that the lender will have a specialist underwriting approach for this type of lending. That's likely to require a broader overview of the whole financial position rather than simply looking at each property as a standalone proposition.
On a positive note the statement recognises that existing landlords wanting to switch to a better deal should not be constrained by the tougher rules, where they are not adding to their borrowing. How useful that is practically will largely depend on how lenders adopt the approach in assessing borrowers.
In conclusion, landlords will need to keep a close eye on developments but lending criteria could tighten. On the upside mortgage rates are extremely competitive so it makes sense to take advice and shop around for the best deals for your individual circumstances.
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