Bank of England Buy to Let affordability rules update

by Property 118

8:47 AM, 30th March 2016
About 4 years ago

Bank of England Buy to Let affordability rules update

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Bank of England Buy to Let affordability rules update

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%.

 



Comments

Trendo

0:37 AM, 30th March 2016
About 4 years ago

c24 will steal a lot of stress testing safety margins for a lot of LL

Recardo Knights

8:41 AM, 30th March 2016
About 4 years ago

I think most investors have a brain and already assume that if they get a mortgage at 4% they already plan to see if it is affordable at 8%-9% as I did.
Also sure that while income, and 125% on rent has always been applied by my mortgage providers, the last few mortgage were stress tested with the guidelines that came in a few years ago.

I think the BoE are right about the fall in mortgages, but not because of the stress test, but because LL will now be selling not buying due to new tax, CGT ,stamp duty, along with other pressures now on LL.

Neil Patterson

9:43 AM, 30th March 2016
About 4 years ago

I have updated this article with the Full Bank of England Proposals for affordability if you wish to take another look 🙂

syed shah

12:18 PM, 30th March 2016
About 4 years ago

I read that product transfers and remortgages on buy to let's that the new proposals will not be affecting these??

saul jacob

12:28 PM, 30th March 2016
About 4 years ago

I expect there may be another rush to lock into long term fixed rates even though the overall long term costs will be some what more in order to do so.
The very essence of the landlord as a person with business acumen some money to invest and a willingness to take 'risks' is the underlying belief that any govt or such authority should get out of the way and let the market do it's work. Markets of course over time go up and down. Therefore I cannot agree with any sentiment that agrees with government intervention, especially to this degree. Those left behind will have a chance when the market takes a fall at some point with some existing fingers burnt probably including my own and there will be others who will time the course set okay. The (great) crash was largely to do with regulatory authorities not allowing financial institutions to go under when they ought to of. I cannot see how such socialist tactics can ever work and by generally agreeing that what the Govt/BoE are doing and going to try and do, is therefore a significant concession to the principles and ideals of a socialist state. The govt should get out of the way and those that fall 'too far' down can be taken care via the the established fiscal purse. *That also means Not trying to manipulate and self manufacture the property market. Or any other major market for that matter.

Neil Patterson

13:04 PM, 30th March 2016
About 4 years ago

To avoid existing borrowers being adversely impacted when remortgaging, the proposals do not apply to buy-to-let re-mortgages where there is no additional borrowing beyond the amount currently outstanding under the existing buy-to-let contract.

Above from BofE document

Andrew Tokely

13:08 PM, 30th March 2016
About 4 years ago

Stress testing at different rates is just prudent and I would hope LL and banks had done this anyway with many using 5% or more already. How was the 125% determined when looking at affordability in the past?

Surely the 125% must represent something. Having not worked in the banking industry would this % have come about due to accounting for voids and costs (maybe not tax)? If this is now applied to the after cost expenses (at some agreed % as everyone is different) then are we not we double counting?

Would be interested to hear from someone who has more experience than me.

Neil Patterson

13:33 PM, 30th March 2016
About 4 years ago

Hi Andrew,
The 125% was based on the interest only part of the loan so didn't take into account any capital repayment or margin for error such as voids. The figure just became an industry norm I would guess through competition as was at one point the maximum roughly a property would stress test out with an average old max LTV of 85%.

Dr Rosalind Beck

13:38 PM, 30th March 2016
About 4 years ago

Reply to the comment left by "Neil Patterson" at "30/03/2016 - 13:04":

Thanks for pointing this out, Neil. It is reassuring to know it will not apply to remortgages, as that was my main concern. Thanks again.

Graham Kogan

20:18 PM, 30th March 2016
About 4 years ago

Do we know what the timescale for the application of these proposals is?

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