Buy-to-let borrowers will face more scrutiny from January because of new affordability checks and mortgage repayment “stress tests”.
The Bank of England’s Prudential Regulation Authority will for the first time ask banks and specialist lenders in the sector to verify that landlords can afford to pay the mortgage in a scenario where interest rates rise to 5.5 per cent.
It is also recommending that the “interest coverage ratio” — the ratio of rental income to mortgage payments — is at least 125 per cent.
Lenders said these changes would further professionalise the market and reduce the number of landlords with only a small number of buy-to-let properties. The government has announced that from 2017 there will be new limits to the tax relief landlords can claim on mortgage interest payments and, as of April 2016, anyone buying a second property must pay an extra three percentage points of the value in tax.
Though the BoE has said the interest coverage ratio should be at least 125 per cent, lenders are likely to set a higher threshold of 145 per cent, in anticipation that buy-to-let mortgages will be less affordable because borrowers are losing some of the tax relief on their interest payments.
Lenders such as The Mortgage Works, a subsidiary of Nationwide, and TSB had already moved to 145 per cent during the PRA consultation on the changes. The effect will be that buy-to-let borrowers will be offered smaller mortgages against property values.
Steve Olejnik from buy-to-let mortgage broker Mortgages for Business, said it was “the end of 125 per cent” for individual borrowers.
“The Bank of England is assuming that every borrower is a higher rate taxpayer. If you feed that into your affordability model, then 125 per cent does not work.”
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However, he said the 125 per cent rate would still apply for landlord businesses held as limited companies — an increasingly popular form of ownership. Mr Olejnik said 63 per cent of his company’s buy-to-let borrowers were now buying through corporate structures, up from 18 per cent two years ago.
The BoE made its initial proposals for tighter buy-to-let affordability rules in March, with the aim of preventing landlords from getting into difficulties if their income dropped or interest rates rose sharply. A consultation on the proposals ended in June.
Strict new affordability checks for other parts of the mortgage market were introduced in 2014.
As an alternative to the interest coverage ratio test, lenders can use a borrower’s personal income to justify a loan — but landlords will have to provide details of personal finances including evidence of income, pensions, savings, tax liabilities, credit card debt or car loans, utility bills and spending on food and childcare. “Lenders are going to have to be a lot more curious about customers’ income,” said Mr Olejnik.
Questions arose during the consultation about whether lenders could assume that landlords would raise rents to help meet mortgage payments. The PRA has yielded some ground on this, allowing lenders to assume rental inflation up to 2 per cent a year.
It has also waived a 5.5 per cent “stressed” interest rate test for fixed-term loans of five years or longer, though lenders noted it had reserved the right to change this if this type of loan became popular.