If you’re a portfolio landlord in the buy-to-let business and you’ve not had to borrow additional funds from a lender since 2016, then you’re about to find out that the lending world has most certainly changed.
According to the PRA:-
“A landlord will be considered to be a portfolio landlord where they have four or more mortgaged buy-to-let properties across all lenders in aggregate”
What this means is, a portfolio landlord will now go through a much more rigorous process with a lender with regards to applying for a buy-to-let mortgage or increasing an existing mortgage. The lender will now undertake a full analysis of your entire property portfolio as part of the lending process.
Graeme Smallman a Chartered Financial Adviser & Mortgage adviser at Phare Financial said,
“This was a seismic change to lenders in how they were underwriting cases, training as well as positioning for market share; and so the PRA changes did not actually reach many of our portfolio landlord clients until sometime after.”
When did everything change?
In 2015/2016 the Prudential Regulation Authority (PRA) undertook a review of the buy-to-let market. This led to an announcement on the 29th of September 2016 with a Supervisory Statement (SS13/16) outlining the PRA’s expectations of the lending firm’s underwriting standards for buy-to-let mortgage contracts.
These new minimum standards would apply to firms who underwrite buy-to-let mortgage contracts.
What is a BTL contract?
A BTL contract is a loan in sterling(£), which is secured on a piece of land in the UK where at last 40% of the land is used or is intended to be used, as a home. The land must not be occupied as a home by the borrower or by a related person. There must be a rental agreement in place, such as an Assured Shorthold Tenancy Agreement (AST)
Lending that does not constitute a BTL loan.
The following types of lending are not deemed to be buy-to-let lending:-
- Bridging loans
- Development loans
- Loans for construction of new builds
- Loans to housing associations
- Loans secured on holiday lets
- Student blocks where the purpose of the building is solely for students (e.g.halls of residence)
Why did everything change?
The PRA took action to ensure that the standards of underwriting remained high during a time when landlords were facing many tax and legislation changes e.g. Section 24, the removal of finance interest costs as an allowable expense and the removal of the wear and tear allowance. By outlining a minimum standard, the PRA felt this would reduce the risk of irresponsible lending. There was evidence to suggest that some lenders were carrying out inappropriate lending and the risk for excessive credit losses were increasing.
For lending firms to meet the new standards they must carry out Affordability Testing.
This is designed to reduce the probability of a landlord defaulting on a loan. And when a lender assesses the affordability in respect of a potential borrower, they will take into account likely future interest rate increases. The PRA also expects firms to consider the borrower’s refinancing risk at the end of the fixed period.
The lender carries out three tests.
- Interest coverage ratio (ICR) calculation
- Income affordability test
- Interest rate affordability stress test stress
The stress test is calculated at 2% higher than the interest rate agreed for the loan and subject to a minimum of 5.5%. The calculation of the interest rate affordability stress test is to be based upon ‘net’ rental income and not ‘gross’ rental income. In other words, the lender will deduct all of the property-related costs from your rental income before arriving at a net rental income.
Exclusions from Stress Testing
A lender is not obliged to fulfil PRA requirements if:-
- The application is from an existing borrower asking for consent to let
- It is a buy-to-let loan on a residential property with a term of 12 months or less
- The buy-to-let loan on a residential property is being re-financed and where there is no additional borrowing beyond the amount currently outstanding under the original buy-to-let loan
- Where an entity has borrowing of more than £3m it is excluded from stress testing as this lending requires specialist underwriting along with credit approval.
- The transition from individual banking to a Sole Trader or Partnership on purchase of a 4th property is deemed to be a re-finance and therefore exempt from PRA underwriting.
Tax Changes from 6th April 2017
Tax Changes (Section 24) are phased over four years and are taken into consideration when assessing the affordability of lending and the repayment capacity of the borrower.
What does this mean for Portfolio Landlords today?
The first thing to understand is that the process of borrowing money may take longer and the lender will have to complete a total portfolio assessment.
S24 changes can easily make a basic-rate taxpayer a higher one, or push a higher-rate one into an advanced rate.
And now it’s not just the tax increase that hurts; the cumulative effect on your cash flow when making payments on account and the knock-on effect to your borrowing ability should not be underestimated.
Simply put; paying more tax will reduce how much you can borrow and therefore grow.
This more than anything will cause the biggest problems, and if you want to borrow more, then minimising the amount of tax you have to pay is essential.
It’s also worth highlighting here that you shouldn’t assume that incorporating will solve the problem either. Rate differences, restrictive terms, redemption penalties and transactional costs to one side, if your long term goals include taking money out of the business then you may face double taxation too, thus reducing the financial attractiveness of doing so.
Choosing the right buy-to-let lender for your mortgage now requires a little more thought and consideration too. You should look carefully at the calculations used by lenders to ensure you’ve found the most cost-effective mortgage product.
Portfolio Landlords will also have to ensure that they have all the necessary details to hand.
Buy-to-let lender may ask for:-
- bank statements
- tax returns
- future liabilities
- rental accounts
- income and expenditure statements
- and a business plan!
The important thing to remember is that lenders have different minimum criteria requirements and not all landlords and property types will qualify for a specific product.
Why are the new rules not such a bad thing for Portfolio Landlords?
The Government wants landlords to run as professional businesses and so tightening of rules does create excellent conditions to make sustainable profits. Landlords who run professional property businesses will be more likely to achieve their goals
In summary, BTL lenders now look at:
- Your property investment experience
- The total amount of your mortgage borrowing across all properties
- Your assets and liabilities, including tax liability
- The merits of any new lending in the context of your existing buy to let portfolio together with your business plan
- Historical and future expected cash flow from your portfolio
- Your income from both property and elsewhere
And for a summary of all the UK Tax Changes over the years, visit our blog page UK Property Tax Changes: A Summary of HMRC Updates