Following the PRA announcement that new underwriting standards will be introduced for buy-to-let mortgages RLA company secretary Richard Jones has produced a briefing informing landlords how the new rules will affect them.
The Bank of England Prudential Regulation Authority (PRA) has now issued new underwriting standards for buy to let mortgages which they regulate.
The intention is that the standards will be brought in from January 1st,2017 onwards, although, in reality, many lenders are already observing them.
The new standards don’t apply to the refinance of existing loans, as you do not borrow more than you currently owe. Refinancing of existing buy to let loans is therefore excluded.
Special treatment is now needed for so called “portfolio” landlords, where you have four or more buy to let properties, whether with the same or different lenders and short terms loans for a term of less than a year – for example bridging loans – are excluded.
PRA requirements now mean –
- Lenders must assess all buy to let mortgage contracts to decide whether the borrower will be able to pay the sums due – regardless of who the borrower is whether an individual or a limited company.
- If the rent alone is sufficient to repay interest then the interest coverage ratio test applies with a minimum interest coverage of 125%.
- If other income is to be taken into account, as well as the rent from the property, an income affordability test is to apply and this can apply as well as the percentage coverage test.
- When applying the interest coverage test lenders are required to have the rent checked by their valuer or otherwise verified. The test must take account of all charges, e.g. repairs, insurance etc.
- Lenders must also take into account tax liabilities and this is now very important as mortgage interest will only be allowed against tax at basic rate for individuals.
- Where personal income supplements rent and an income affordability test applies lenders must look at all sources of income and set off against these all credit commitments including all other mortgages and other types of lending, e.g. credit cards. Essential expenditure and living costs are also taken into account such as food and utilities. Likewise, expenditure relating to rental properties is to be taken into account.
- Future interest rates must be taken into account. Stress testing must take place over a minimum period of five years unless the interest rate is fixed/capped for at least five years. A minimum rate of 2% above current rates must be applied with a minimum of 5.5%.
- Lenders can assume rate rises in these calculations of up to 2% per annum.
- For portfolio landlords, a specialist underwriting approach is required. Lenders can look at the lender’s experience in the buy to let market and their overall portfolio and may want business plans as well as cash flow projections.
The PRA will review lender’s practices and procedures so landlords must expect some tightening up, although much has already changed since the onset of the 2008 Great Recession.
Already many lenders used apply higher interest coverage percentages anyway. One change may be the minimum required 5.5% as a minimum interest figure when applying the tests.
Unfortunately, all of this could create extra hurdles for landlords seeking a mortgage to jump through and undoubtedly the changes to mortgage interest tax relief mean that lenders are taking a more conservative view when considering buy to let mortgage applications.