Buy-to-let landlords face tighter borrowing rules under plans by the Bank of England's regulation arm, the Prudential Regulation Authority (PRA).
The changes under consultation include more stringent affordability and repayment assessments amid warnings that increasing levels of lending pose a risk to the property market.
Here is a breakdown of the proposals and how they could affect investor landlords:
The PRA wants lenders to make income checks tighter for buy-to-let investors to reduce the probability of defaulting on a loan especially when interest rates rise.
Currently, rental income and capital growth (the increasing value of the property) is an important factor taken into consideration by underwriters.
The new proposals could see more affordability testing for investors in the form of:
- an interest coverage ratio (ICR) - a measure of how the investor can repay the debt before interest and taxes, and/or
- an income affordability test - where lenders take account of the borrower's personal income to support the mortgage payment.
These measures would assess variables including:
- 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 costs.
- clarification regarding application of the small and medium enterprises (SME) supporting factor on buy-to-let mortgages.
Interest rate affordability stress test
The buy-to-let market is characterised by floating, or relatively short-term fixed mortgage rates usually on an interest-only basis.
The PRA says that this makes buy-to-let lending particularly sensitive to changes in interest rates and proposes measures to assess the investor's ability to cope with rising interest rates.
It proposes that lenders:
- consider the likely future interest rates over a minimum of five years from the start of the contract or for the duration of the contract if less than five years.
- carry out interest 'stress tests' based on market expectations and a calculation based on a minimum increase of two percentage points and any Financial Policy Committee (FPC) direction or recommendation.
- Assume a minimum borrower interest rate of 5.5% even if the stress tests indicate a lower rate.
Data shows that there is an increase in observed arrears rates of landlords with buy-to-let portfolios of four or more, the PRA said.
The PRA proposes:
- Investors with four or more properties would be considered a portfolio landlord.
- Firms should introduce a special underwriting process for portfolio landlords that accounts for the complex nature of the borrower and their properties.
Firms should also have robust risk management, systems and controls in place specifically tailored for buy-to-let properties, it is proposed.
The consultation closes on Wednesday, June 29.