Buy-to-Let Property Lending

Posted on 15/04/2016 · Posted in Expert Information

By David Griffiths – Head of Property Lending Litigation

There has been strong reaction to the Prudential Regulation Authority’s (‘PRA‘) Consultation Paper: “Underwriting standards for buy-to-let mortgage contracts” published in March 2016.

Press comment describes the Paper as an attempt by the Bank of England, of which the PRA is a division, to crack down on buy-to-let lending and the move is also seen as being made in tandem with the new 3% stamp duty surcharge, and the reduced tax allowance on buy-to-let interest costs, which came into force on 1st April. The overall aim appears to be to cool the housing market, in general, and the buy-to-let market, in particular. In some senses this is understandable as the stock of buy-to-let loans has risen by 40% since the financial crisis, although the PRA’s move has been described by the former RICS chairman, Jeremy Leaf, as “…a classic case of slamming the stable door after the horse has bolted.

Obviously, the increased appetite for buy-to-let investments is, at least in part, a reflection of the ultra-low interest rates to be earned on deposits and the desire of investors to achieve a reasonable return on their money.

The existing standard criteria are centred on Loan to Value ratios combined with ensuring that rent covers interest with a surplus to cover costs, also expressed as a ratio. These criteria should give a lender a cushion of security if the property had to be repossessed and the rental income would make the property an attractive investment to a would-be buyer. The standard criteria in place in mid-2007, before the crisis at Northern Rock were a maximum of 85% Loan to Value and a 120% interest cover from rental income. In a stable or rising market, these were criteria that had helped lenders experience extremely low levels of defaults – in 2006, just 0.2% of buy-to-let properties were repossessed and less than 0.6% of buy-to-let loans were in default, compared with 0.85% for the mortgage market as a whole. The current (2nd quarter 2015) level of defaults in the mortgage market, as a whole, is also now very low at 0.96% but the level of buy-to-let defaults is even lower at 0.33%.

The tax changes, by themselves, will have made buy-to-let investments less attractive and it would be common sense to factor into a lender’s affordability calculation that the tax allowance on interest costs has reduced to 20%, whilst the stamp duty will have affected the investor’s rate of return on purchase costs.

Currently, most buy-to-let mortgages are written at Loan to Value ratios of around 75% with interest cover from rent at around 125%. As such, these are more conservative than pre-recession levels and are likely to be a contributing factor to the lower level of defaults now than pre-recession.

The PRA’s proposals to strengthen these criteria are two-fold. In terms of interest cover, it is proposed that interest rates should be taken to be at an assumed level of 5.5% and/or that the assessment should assume an increase of 2% over current levels of interest cost. It is also proposed that the overall strength of a proposed borrowers covenant be assessed, with the information checked, in order to ensure affordability.

The PRA’s paper says that factors to be taken into account are:

  • 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, credit commitments, committed expenditure, essential expenditure and living costs.

Although there is no mention of self-certification, such are the factors listed, at least some degree of self-certification appears to be inevitable, otherwise the volume of supporting paperwork would be very onerous.

The position in respect of corporate investors is largely unchanged, although there is speculation that the changes in stamp duty will fuel a rise in build-to-let loans. In fact, this is already happening and Private Rented Sector development is already established as a significant feature within general residential development for major corporate investors. Plainly, the criteria for assessing project finance for residential development is in a different league to simple buy-to-let lending and the assessment of corporate investment sector loans will involve analysis of the strength of the underlying borrower’s covenant, usually by balance sheet analysis. It may be argued, therefore, that nothing will have changed in respect of the standards of credit assessment to be applied to corporate borrowers.

However, whatever the political and economic thinking behind the PRA’s proposals from a lending criteria point of view, with regard to the assessment of buy-to-let loans for individuals, the changes mark a change in the criteria which the market can be expected to adopt in writing new buy-to-let mortgage business. In many ways, and looking at it dispassionately, this provides a very useful yardstick for how a ‘reasonably competent lender’ should conduct itself in writing new loans from now on.

For directory of articles on expert witness services please click here.

Ask a question about expert witness services. We are here to help!

Contact Us Now

Expert Evidence is a professional firm concentrating on the four main areas of dispute resolution; acting as expert witnesses in financial litigation, mediation, arbitration and adjudication. The firm has a civil, criminal and international practice and has advised in many recent cases. Areas of specialisation include banking, lending, regulation, investment, and tax.

Disclaimer – Please confirm any of the above views with your solicitor. Expert Evidence takes no responsibility or provides any guarantee that the views above are correct for your particular case or jurisdiction.