11:17 AM, 30th November 2020, About 3 years ago
The PRA has highlighted to lenders that section 24 rental income tax changes have made BTL investments more expensive for high rate taxpayers and lenders are not fully accounting for this when assessing affordability.
Banks routinely look for a minimum stress testing or Interest Cover Rate (ICR) of 125% calculated against monthly interest at a notional rate. This calculation reflects the amount of gross rental income required for landlords to breakeven, factoring in the costs of mortgage repayments (including a potential increase in interest rates), tax and property maintenance.
In a Bank of England Overground article the PRA said it:
“Expects lenders to take income tax into account when assessing affordability. If the Mortgage Interest Tax Relief (MITR) (section 24) changes were strictly enforced for affordability testing, higher-rate taxpayers would need to meet a higher stressed ICR of 167% to be assessed to the same standard as an ICR of 125% for basic-rate taxpayers.
“Most lenders assess higher-rate taxpayers against a minimum stressed ICR of around 145% (Chart A). So compared to basic-rate taxpayers, lenders are accepting a lower net rental income for given mortgage repayments for higher-rate taxpayers. All else equal, this could make lending riskier.
“However, the risk posed by such lending is low at present. The overall quality of buy-to-let lending has improved since 2016. And tax changes introduced since 2016, including the MITR, have meant the buy-to-let market has been very subdued.
“Lenders may also take into account that higher-rate taxpayers have higher incomes and tend to have more diversified income sources to finance their mortgage repayments. More detailed analysis would be needed to fully understand the balance of these risk factors.
“We will continue to monitor this risk in buy-to-let lending.”