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Buy-to-Let mortgage restrictions explained

Posted on 2016-05-25

In late March, one of the Bank of England's regulators revealed its proposals for stricter buy-to-let mortgage lending criteria.

The Prudential Regulation Authority's (PRA) proposals are a result of a consultation which was launched in January after the Bank of England's Governor, Mark Carney, expressed concern over the buy-to-let market late last year.

The restrictions centre around lending criteria and affordability. Landlords will now have to prove to lenders they can meet mortgage payments in the event of a significant interest rate rise before being granted a buy-to-let mortgage.

At the time the proposals for the changes were announced, the PRA reported that approximately 75% of lenders already comply with their lending criteria. However, the Authority claims that five of the 20 biggest lenders are offering stress tests below the new levels proposed.

The PRA's proposals come at a time when a number of new measures have been introduced to the buy-to-let market. Purchasers of a buy-to-let property now have to pay an additional 3% in stamp duty and last year it was announced that landlords' mortgage interest tax relief is to be restricted to the basic level of income tax.

These rules were both introduced by the Chancellor, George Osborne, in order to level up the playing field between landlords and first-time buyers and he recently claimed that it is no coincidence that the PRA and Bank of England's buy-to-let clampdown has come at around the same time.

He said it's all part of a wider package to restrict the lettings sector’s impact on the economy.

The lending restrictions are likely to be approved in the next couple of months and there are varying reports suggesting they'll either be introduced later this year or in early 2017.

Buy-to-let mortgages are of course a significant consideration for landlords and so we've taken a closer look at the PRA's proposals and how they could affect investors...

Who – The Bank of England's Prudential Regulation Authority (PRA) has proposed rules to control buy-to-let lending to landlords and property investors.

What – A set of restrictions which will make it more difficult for landlords to obtain buy-to-let funding from mortgage lenders in order to control the market. Borrowers will have to prove they can cover mortgage repayments in a worst case scenario.

Why – So that the buy-to-let mortgage market does not get 'out of control'. The PRA predicted that if no restrictions were introduced, in the next few years, lending would increase by around 20%. It says that the new system should result in the number of buy to let mortgage approvals reducing by between 10% and 20% by 2019.

Where – Across the whole of the UK

When – The proposals were released for consultation at the end of March, due to be approved by
the Bank of England this summer and then officially introduced later this year or in early 2017.

How – Buy-to-let lenders will have to carry out stricter 'stress tests' on prospective borrowers, making sure they have the capital to cover repayments in the event that interest rates increased to 5.5% for a full five years.

Will it affect existing buy-to-let mortgages?

The new system is designed to stop people being given buy-to-let mortgages that they can't afford to pay back in the future, rather than making it more difficult for those already with a mortgage to pay back their lender.

However, one mortgage expert has criticised lenders for offering a range of products which could cause an 'affordability bubble'.

Simon Bayley, Foundation Home Loans' Commercial Director, said that 'pay rate' products which are being issued at the moment on fixed or lifetime trackers could have significant consequences when the PRA's new stress test system is introduced.

"When landlords come to refinancing they will have to fulfil the PRA criteria of a minimum stress rate, which could leave them as ‘mortgage prisoners’ and unable to refinance away from their current lender," he said.

He said landlords will no longer be able to use 'pay rate' - the initial rate offered before the deal ends – and the 5.5% stress test could stop them from refinancing.

The Residential Landlords Association (RLA) has backed the proposals by agreeing that no landlord should take on debt that they can't afford, but has warned that they are 'premature' due to the tax changes currently being introduced.

The trade body said that the surge in buy-to-let activity in recent months is most certainly as a result of tax changes and so the market is likely to cool in the second half of 2016.

David Smith, the organisation's Policy Director, believes the PRA's measures could 'stifle' the supply of rental properties the country needs by reducing the demand for borrowing.

How might it impact on market entrants?

If, as expected, the Bank of England ratifies the PRA's proposals in the next few weeks, then the new lending rules could be introduced any time from later this summer to the beginning of 2017.

The tougher stress tests for borrowers will affect those trying to secure funding whether they are entering the buy-to-let market or working to expand their current portfolio of properties.

Already, one lender – Fleet Mortgages – has spoken out, warning that landlords who apply for a buy-to-let mortgage or remortgaging loan will find it more difficult to secure funding once the new rules are introduced.

The firm's chief executive, Bob Young, said it's more likely 'that activity levels begin to increase again over the course of the year as we get closer to the implementation of the rules.'

As well as borrowers finding it more difficult to get funding, increased capital requirements will also impact on lenders' ability to offer the same levels of funding, according to Young.

It's clear that the Bank of England and the PRA's proposals will have an impact on borrowers and some landlords will find it difficult to get access to the funding they require.

Although the new rules come at a difficult time – where landlords and investors are having to adapt to a variety of market changes – one positive is that they may stop some prospective landlords encountering serious financial problems in the future.

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