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

Andrew Tokely

20:59 PM, 30th March 2016
About 4 years ago

Reply to the comment left by "Graham Kogan" at "30/03/2016 - 20:18":

The document requests responses by 29th June 2016. Then I guess - how long is a piece of string. The mortgage lenders seem to be fighting it, as expected, from what I can pick up on various forums.

Who knows if it will take the form of the consultation, or be watered down, or beefed up. We need to wait and see. the document is here and actually pretty easy to read but the article abiove pretty much says it all ----> http://www.bankofengland.co.uk/pra/Documents/publications/cp/2016/cp1116.pdf

David Hamilton

9:12 AM, 1st April 2016
About 4 years ago

It could be difficult to make deals meet the new affordability criteria with net rental income. The FT have reported the new rental income as:

"This should be at a minimum of 125 per cent, the PRA says, and the calculation should take into account all costs of buy-to-let, including estimated voids, council tax, repairs, letting-agents fees and utility costs." http://www.ft.com/cms/s/0/a8fce3ce-f755-11e5-96db-fc683b5e52db.html

Deducting these costs and any addition tax due to Clause 24 will have an impact for me. Out of curiousity I put a few figures into Accord's affordability calculator. http://www.accordmortgages.com/btl/rental-calculator/index.html

A property with £1,000pcm gross rent would support at mortgage of about £175,000 at 5.5% 125 ICR

Deducing 10% agent fees, 10% maintenance, 20% extra tax due to Clause 24 only supports a mortgage of £111,000 at 5.5% 125 ICR

For those landlords who are suffering from excessive maintance charges on leasehold properties the position could be even worse. Finding properties worth around £150,000 that rent for £1,000pcm isn't easy in the South East.

They have stated that the rules won't affect remortgages, however that wasn't how things panned out in practice for owner occupier mortgages, hopefully it won't pan out that way for us!

H B

12:46 PM, 2nd April 2016
About 4 years ago

Reply to the comment left by "David Hamilton" at "01/04/2016 - 09:12":

"They have stated that the rules won’t affect remortgages, however that wasn’t how things panned out in practice for owner occupier mortgages, hopefully it won’t pan out that way for us!"

This is my concern too. It seems to have been added as a throw away remark so as not to cause panic. But how does this work in practice?

If the new standard is what the Bank of England feels is the minimum required to underwrite mortgages safely then why would it be happy to allow a bank to lend to "unsafe" borrowers purely because they are remortgages?

If Bank A only writes mortgages under the new standard and Bank B under the old standard, which bank has the "safer" mortgage book according to the Bank of England? Bank A obviously, so it gets lower capital requirements and can price more cheaply.

This will inevitably affect every BTL mortgage, not just new purchases. Do not believe some weasel words which look like they were added as an after thought.

Jon Pipllman

10:40 AM, 3rd April 2016
About 3 years ago

I would go as far as to say that the days of high leverage (for that read >50% LTV) are coming to an end.

David Hamilton has posted something very similar to one of my earlier posts on this thread: the LTV supported by a loan on the terms proposed by the BOE consultation is around 50% tops at current house prices / rental yields.

If you want some positive cashflow from the property too, the LTV has to be lower still.

Again at the risk of further repeating myself, Basel III is on the horizon too. There are some interpretations of those rules that make 5.5% look very cheap for a BTL mortgage. Base rate + 8% (and more) interest rates are talked about by some commentators.

Monty Bodkin

20:47 PM, 6th April 2016
About 3 years ago

Reply to the comment left by "Jon Pipllman" at "03/04/2016 - 10:40":

Basel III is on the horizon too.

And?

If you know, or even think you know, more than anyone else, then say so and speak openly and honestly.

Hiding behind curtains shouting "Boo!" belongs on another site.

Jon Pipllman

18:53 PM, 8th April 2016
About 3 years ago

>monty bodkin

I, amongst others, have mentioned Basel iii here many times before. It has been widely communicated about in the broader landlord press too.

That mention of it now is a surprise to you surprises me.

You will find plenty of reference to it using the search on this forum and I will, as a starter for 10, post (again) this link to the CML's response to the Basel iii consultation, that is presented alongside it's response to the BOE's recent PRA consultation.

https://www.cml.org.uk/news/press-releases/cml-responses-on-fpc-powers-and-basel-urge-evidence-based/

Whilst I don't profess to be an expert on it, if you have a specific question about it, I will have a go at answering it

Monty Bodkin

9:30 AM, 9th April 2016
About 3 years ago

Reply to the comment left by "Jon Pipllman" at "08/04/2016 - 18:53":

I'm surprised you are surprised you think this is a surprise to me!

Basel has been common knowledge for a long time for those who have an interest in such things.

It will have no negative effect on my business, on the contrary, I see prudent lending as a good thing helping to stabilise the market. It is not the bogeyman the doomsters are hoping it will be.

Jon Pipllman

11:32 AM, 9th April 2016
About 3 years ago

> Monty Bodkin

I agree with you re prudent lending. We should remember that it was mostly unfettered lending that led to the bank crisis in 2008. Regulators (e.g. BOE via the MMR and PRA and Basel with III) are only just now pushing some measure of prudence onto lenders as part of their attempts to prevent such a crisis visiting again.

I think the impact of Basel III could be more significant to the UK BTL market (in that it will cause more borrowers to only be able to borrow at higher interest rates) than the BOE PRA consultation (which, although it might hit harder to those caught by it, will affect fewer borrowers than Basel III will).

However, by the time Basel III is implemented, Clause 24 and the BOE PRA consultation will have already effectively ended new entrants moving into highly leveraged BTL. Basel III will then push up borrowing costs a bit more and, therefore, push down the LTV that works to a bit lower level.

As far as I can see, leveraged BTL post Clause 24, post PRA and post Basel III is only going to work at LTVs somewhere considerably less than 50%.

If I am right, I will be looking to buy again once the cumulative impacts of these changes washes through. I expect to be able to buy great properties at decent yields again in due course If I am wrong, hey ho.

Arun Damodaran

14:45 PM, 21st April 2016
About 3 years ago

Hi all,
Does this reflect that most (if not all lenders) would borrow only 5.5% of loan amount * 1.25 for operating costs. Then surely 75% LTVs may not stack up any more. One would have to go for 60/ 65% LTVs to make the figures work?
Regards
Arun

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