Stress Tests have increased compared to base rate?

by Readers Question

11:25 AM, 18th July 2016
About 2 years ago

Stress Tests have increased compared to base rate?

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Stress Tests have increased compared to base rate?

I am Looking in Depth at the remortgaging process and I have seen some big changes to the BTL lending criterias of recent as I haven’t re mortgaged for a number of years. stress testing

Being from the South East where yields are not that good what are people thoughts on what looks to be all lenders applying stress testing i.e…The rental income must cover 125% – 145% of the mortgage interest calculated at a notional rate of between 4.99 and 5.99% depending on which lender even though in many cases the actual pay rate is only around 2%.

Surely this is a bit excessive?

This seems to be a bit of a brick wall as I cant see how any product above 60% LTV would stack up in the South East on remortgages or purchases. Surely this must be preventing many thousands of BTL investors from re mortgaging at all, let alone releasing money.

What happens when Base Rate does start to go up and Landlords then decide to fix everything quick, but cant because the stress testing is preventing them from doing so, because the figures just don’t stack up?

How are investors releasing funds from existing properties, second charges? Maybe I am missing something, but surely this is a problem.

Rob



Comments

Neil Patterson

11:32 AM, 18th July 2016
About 2 years ago

Hi Rob,

Back in March the Bank of England through the PRA issued new directives to lenders regarding minimum stress testing criteria for BTL to ensure stability in the market if rates were to rise.

Please see the article >> https://www.property118.com/bank-of-england-impose-stricter-lending-criteria-on-the-buy-to-let-market/85732/

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%.

Neil Patterson

11:33 AM, 18th July 2016
About 2 years ago

If interest rates do eventually increase then it does not necessarily mean the stress testing will follow like for like as it is already taking into account and increase now.

Monty Bodkin

15:38 PM, 18th July 2016
About 2 years ago

Don't see a problem with remortgaging in the SE unless you took on some pretty rare & risky 90% LTV mortgages and bought unwisely.

Hard to discuss without your specifics but even if you were the unlucky few buying at the 2007 peak, prices in the outer SE have still increased since then around 20% on average (with the corresponding decrease in existing LTV's) ;

http://www.nationwide.co.uk/about/house-price-index/house-price-calculator

IIRC, mainstream lending criteria was usually around 5% at 125% rental income. It is now around 5% at 145% rental income.

Rents have gradually increased in outer SE. You don't specify an exact date in your 'number of years' ago but using the LSL or Homelet average rental indexes as a rough guide, a conservative working example would easily fit;

£120,000 Mortgage 2007 at 5% = £500 pcm x 125% = rental income required then £625

£120,000 Remortgage 2016 at 5% = £500 pcm x 145% = rental income required now £725. Rents have comfortably gone up by that much.

Some SE landlords might struggle to remortgage but on average, most won't.

And why would they want to remortgage anyway? If they have mortgages taken out a number of years ago, chances are, they are now on an ultra low reversionary BofE tracker rate paying half what they were originally. With a good chance of an extra payday next month should the base rate be dropped further to add to the reserve fund for when rates do eventually rise.

New purchases will be hard to stack up but that is good news for existing landlords as it puts upward pressure on rents and it helps to stabilise the market.


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