Bank of England Buy to Let affordability rules update

Bank of England Buy to Let affordability rules update

8:47 AM, 30th March 2016, About 6 years ago 30

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Buy to Let Bank of EnglandIn an effort to stem the perceived risk of Buy to Let on the housing market, the Bank of England have imposed new guidelines on lenders to tighten underwriting standards that have slackened since the credit crisis.

Although there are no hard and fast criteria rules the Bank of England want lenders to stress test new Buy to Let mortgages assuming a minimum pay rate of 5.5% as opposed to any current historic lows.

Stress tests assessing affordability will also need to include the Landlord’s costs of letting the property and tax liabilities in doing so.

They have predicted this will affect at least a quarter of the Buy to Let lenders who will have to increase the rates at which they stress test new loans. Typically a loan is stress tested so that the rental income must cover at least 125% of the interest payments at a notional rate, which can be the same as the pay rate, but often not.

The PRA said,”Risks stemming from domestic credit have risen and it remained alert to potential threats to financial stability”.

The Bank of England expects these new measures to decrease the level of Buy to Let lending by a figure between 10% and 20% over the next two years.

The effect of these new guidelines will mean that lenders may have to increase the notional rate to a higher level to cover a possible increase in Bank Base rate. Therefore the rental income will have to cover a much higher figure at 125% and in addition have letting and tax costs taken off the rent before it is multiplied to cover the stress testing.

A hypothetical example of pre and post underwriting changes could be:

£500 rent pcm at a notional rate of 5% and 125% interest cover would cover a mortgage of £96,000

Now if the notional rate was increased to say 5.5% and 20% was taken off for costs then the same rental income would only cover a mortgage of £69,818.

Full Bank of England Proposals Below:

Affordability testing
2.1 Affordability tools constrain the value of the loan that a firm can extend for a given income and can reduce the probability of default on the loan particularly in an environment of rising interest rates.

At higher levels of indebtedness, borrowers are more likely to encounter payment difficulties in the face of shocks to income and interest rates.

2.2 Rental income is an important factor when determining the ability of buy -to-let landlords to service their debt. Accordingly, a widespread market practice in the buy-to-let lending market is to use the mortgage’s interest coverage ratio (ICR) in assessing affordability. In addition to rental income, some borrowers use personal income to support their ability to service their debt.

2.3 The PRA is therefore proposing that all firms use an affordability test when assessing a buy-to-let mortgage contract in the form of either: an ICR test; and/or an income affordability test, where firms take account of the borrower’s personal income to support the mortgage payment.

2.4 The PRA is seeking to establish a standard set of variables that should be reflected within the ICR test and the income affordability test. To ensure that firms are being prudent in their affordability assessment, the PRA is proposing that firms, among other things, give consideration to: all costs associated with renting out the property where the landlord is responsible for payment; any tax liability associated with the property; and where personal income is being used to support the rent, the borrower’s income tax, national insurance payments, credit commitments, committed expenditure, essential expenditure and living cost.

2.5 As affordability constrains the value of the loan a firm can extend, the PRA is not at this time proposing supervisory guidance with respect to specific loan-to-value (LTV) standards. However, the PRA does expect firms to have appropriate controls in place to monitor, manage and mitigate the risks of higher LTV lending. Interest rate affordability stress test

2.6 The buy-to-let market is characterised by floating, or relatively short-term fixed mortgage rates typically on an interest-only basis. These attributes heighten the sensitivity of buy-to-let lending to changes in interest rates, which increase debt service costs.

2.7 Consequently, the PRA proposes that, when assessing affordability in respect of a potential buy-to-let borrower, firms should take account of likely future interest rate increases. In particular, the PRA proposes that the firm should consider the likely future interest rates over a minimum period of five years from the expected start of the term of the buy-to-let mortgage contract, unless the interest rate is fixed for a period of five years or more from that time, or for the duration of the buy-to-let mortgage contract if less than five years.

In coming to a view of likely future interest rates, the PRA would expect firms to have regard to: market expectations; a minimum increase of 2 percentage points in buy-to-let mortgage interest rates and any prevailing Financial Policy Committee (FPC) recommendation and/or direction on the appropriate interest rate stress tests for buy-to-let lending.

Even if the interest rate determined above indicates that the borrower’s interest rate will be less than 5.5% during the first 5 years of the buy-to-let mortgage contract, the firm should assume a minimum borrower interest rate of 5.5%.



Mark Alexander - Founder of Property118 View Profile

13:00 PM, 29th March 2016, About 6 years ago

Whilst I can see that this will trap some BTL borrowers into higher rate standard variable rates I do actually follow the logic on this move.

When I first started working as a broker in the early 90's the lending criteria was 10 times annual rent (Yorkshire Bank).

Given that interest rates will will eventually increase (long term predictions are now circa 3%) and that running costs for most landlords (excluding mortgage interest) are circa 25% to 40% of gross rent I think the BOE's move makes a lot of sense.

I've seen lenders willing to advance up 20 times annual rent (240 times monthly rent) over the last decade or so and have always thought to myself this is highly risky in the long term, not just for them but also their borrowers.

Buy to Let should be an investment to produce positive cashflow as an alternative to depositing savings elsewhere in my opinion.

I appreciate that my views will be seen as controversial to those whose strategies are based heavily upon speculating on capital appreciation but I've always recommended a cautious approach to stress testing as my private consultancy clients will testify to.

James Fraser

13:04 PM, 29th March 2016, About 6 years ago

Is this ltd co loans too or just for individual borrowers?

Neil Patterson View Profile

13:13 PM, 29th March 2016, About 6 years ago

I am assuming both for now as they are largely the same loan.

Jon Pipllman

13:28 PM, 29th March 2016, About 6 years ago

Whilst it could have been far worse (e.g. ban IO loans), the outcome of this exercise should be expected to be lower LTVs available for BTL LL's.

Roughly roughly, £100k borrowed at stress test interest rates of 5.5% = £5,500 interest. This would (if I have read the meaning of clause 2.4 in the BOE document correctly) have to be covered 125% net of income tax for the LL.

So, for a 40% tax payer, that would mean that £100k borrowed would need £11,458 rental income. If property yield is 6%, that implies the £100k loan could only work where the price of the property was £191k (52.3% LTV)

If clause 2.4 does not mean that the 125% cover is from after tax income, the above sums are wrong and can be ignored, but I rather think that is what clause 2.4 means

Also, for Portfolio Landlords (4+), I think the number of lenders will likely decrease due to the requirement for more specialist underwriting.

Mark Evans

13:32 PM, 29th March 2016, About 6 years ago

Any responsible property investor will already be employing such methods as suggested by the BoE.

I just hope it doesn't impact the many accidental landlords out there. I imagine landlords that are highly geared will be worried when they exit their fixed deals.

Andrew Tokely

14:14 PM, 29th March 2016, About 6 years ago

They talk base rate of 5.5%. So if they have 3% margin over base (e.g. 3.5% mortgage) then they need to stress test at 8.5%? If they have something like 4.5% over base then it is stress tested at 10%?

Andrew Tokely

15:55 PM, 29th March 2016, About 6 years ago

After reading the actual document it appears that they are proposing an minimum of 5.5% stress test if the current rate plus 2% falls below this amount.

The article above leads to some confusion with the use of "base rate" of 5.5%as often the term base rate refers to the BoE base rate. Should have probably used a slightly different terminology.

As some have said LL should be stress testing at these sort of rates or 2-3% over the rate of the mortgage they have or anticipate to have. I have always stressed at +2 to +3% of the expected rate to be sure.

James Fraser

17:14 PM, 29th March 2016, About 6 years ago

Well me too. I've never, ever, taken on more than was easily affordable and have always used stress tests of my own over and above the mortgage requirements to check my affordability. However, as someone just hoping to get a limited company off the ground, these new requirements aren't exactly going to be conducive to investment. Which I suppose is the point.

There is one, tiny, minuscule glimmer of positivity though - at least when we're taxed to the eyeballs, unable to buy or renovate because of SDLT, and unable to buy affordable property because of the stress tests, at least the anti-landlord brigade won't be able to whinge about how we're to blame for the housing crisis and how we don't contribute enough to the economy!

Mark Shine

20:43 PM, 29th March 2016, About 6 years ago

Reply to the comment left by "Mark Alexander" at "29/03/2016 - 13:00":

I generally agree with your post Mark A, although the anarchic LL haters who permanently monitor this forum may try and make a big deal about the use of the word ‘investor’ elsewhere and everywhere.

I may be wrong but I can see the logic behind today's ‘move’. Most lenders were already applying the stricter lending criteria anyway, so it makes sense for those with looser lending criteria to follow suit for a number of reasons. Obviously it would make no sense for lenders with weaker lending criteria to have market advantage with customers, if there is any financial stability risk to the wider economy.

Sorry to bang on, but I could also see the some logic with the SDLT hike, EVEN if it potentially adversely affects me, although worth repeating that larger purchasers pay lower SDLT on commercial terms.

If pushed, I could even see some sense in SOME elements of the licensing schemes that I now have to comply with.

For me, once again, today’s ‘news’ merely highlights how nonsensical GO’s (or rather his wealthy corporate LL sponsors’) C24 short term tax grab was, for a multitude of reasons that have already been discussed at length.

steve p

22:13 PM, 29th March 2016, About 6 years ago

This is what they should have done at the start instead of C24, this closer fulfills every aim Gauke and GO set out for C24.

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