Property News

Ever since the Prudential Regulation Authority (PRA) published a consultation on buy-to-let lending rules in March of this year, the property and banking industries have been steeling themselves for tough new criteria to be applied to the sector. This expectation was borne out by various statements made by the Governor of the Bank of England (BoE), Mark Carney, suggesting that his institution was taking a long, hard look at the entire buy-to-let sector, to ascertain whether it represented a risk to the country's financial stability. It didn't come as much of a surprise, then, when in late September, the PRA announced a suite of rules for buy-to-let mortgage lenders. In this short article, we look at why the BoE is so concerned by buy-to-let and how the new rules may affect landlords.

What are the new rules?

Without getting too bogged down in ‘Regulator speak’, the PRA has published a timetable for lenders to introduce new, more stringent requirements for buy-to-let borrowers. The new, tightened lending criteria must be in place by 1 January, 2017.

Briefly, it will be mandatory for lenders to require landlords to have demonstrated that they will charge higher levels of rent in proportion to their mortgage costs. Additionally, all new mortgages will need to be stress-tested at an interest rate of 5.5 per cent, which is, of course, much higher than existing interest rates. Landlords with a portfolio of four or more properties will also be required to produce more information about their streams of income and financial liabilities. Lenders will, however, be allowed to factor in rent rises of up to 2 per cent per year, when deciding whether a landlord will be able to afford a property. This is a new concession and lenders were not previously allowed to take potential rent hikes into account.

Lenders, says the PRA, must also require borrowers to receive a minimum of 125 per cent of their mortgage costs in rental income, although this is already a widely-adopted industry practice. Importantly, lenders must also factor an applicant's future tax liabilities into the equation, meaning, for example, that the changes to mortgage interest relief which are being introduced from next year will now be taken into account.

More information about the new measures can be found at the following sites:

- http://www.bankofengland.co.uk/pra/Pages/publications/290916.aspx
- http://www.bankofengland.co.uk/pra/Pages/publications/ss/2016/ss1316.aspx
- http://www.bankofengland.co.uk/statistics/Documents/articles/2016/17sep.pdf


Why is buy-to-let such a concern for regulators?

The buy-to-let industry has grown dramatically in recent years and British financial institutions have significant exposure to the sector. In simple terms, the BoE is concerned that many landlords will be unable to pay their mortgages in the event that interest rates are raised. Recent changes in the tax regime affecting landlords are also identified as being potential financial stressors for buy-to-let mortgage holders. If landlords defaulted on their loans en masse, there would be serious repercussions for the wider economy. This kind of risk, of course, is horribly familiar. We recognise it from the financial crisis of 2008.

It's fair to say that the BoE and the PRA's predecessor, the Financial Services Authority, were heavily criticised for failing to identify the signs of trouble before that crisis blew up and for failing to put in place preventive measures. Whether the criticism was fair and justified or not, failing to spot a potential "bubble" in the economy is not something the BoE intends ever to be charged with again - hence the new rules around buy-to-let lending. The fresh approach isn't universally popular, of course. Banks claim that they are already labouring under too heavy a regulatory burden, without the BoE adding to compliance pressures. There is also the belief in some quarters that the BoE is acting in a vaguely paranoid or neurotic way and seeing potential "bubbles" everywhere. Landlords are naturally resentful of a measure that will cost them - and ultimately tenants - more money. With the various government measures aimed at reducing the incentives of this sector, it feels in many ways as though landlords are under attack.


How will the new rules affect landlords?

It's important to preface this section by saying that these are very early days and it's always difficult to foresee all the side effects of new legislation and regulations. Some of the issues will only become apparent in the weeks and months following the implementation of the PRA's new buy-to-let lending rules. A number of major lenders have also been working for some time towards modifying their lending criteria for landlords in anticipation of the PRA's measures, so the new regime will no doubt present fewer problems for these institutions and their borrowers. That being said, the industry has reacted with some disappointment.

The Daily Mail, for example, has traditionally been a consistent and vocal cheerleader for landlords, and quotes property industry experts as warning that "thousands" of potential borrowers could be prevented from buying rental properties as a direct result of the changes. Similarly, they argue that existing landlords wishing to borrow money by cashing in equity on properties in their current portfolios could be affected.

David Hollingworth, of mortgage broker London & Country, is quoted in both the Mail and the Daily Telegraph as having said that: "These rules could prove fatal for small landlords". He argues that individuals wishing to invest in buy-to-let properties to boost their pension pots and incomes will simply be unable to find the extra funds they require for a deposit. They may equally be unable to increase rents sufficiently to make up the "shortfall". The new rules, which, the Mail points out, only affect mortgages of a shorter duration than five years, are also potentially bad news for tenants who, argue landlords, are the ultimate casualty of the entire range of tax laws and prudential regulation aimed at landlords.

The team at Nethouseprices will be monitoring this story as it unfolds and will provide news, analysis and commentary on the issues that will affect you, your business and your investments. Visit us again soon at http://www.nethouseprices.com for the most up-to-date information.