Landlords are facing tougher rules on mortgage borrowing following an announcement from the Bank of England – and the biggest impact will felt in London, experts say.
Buy-to-let has grown massively and now there are concerns about a “bubble emerging in this market,” Chancellor George Osborne said. The Bank believes overly indebted landlords pose a risk to the economy as they may be unable to pay back debt on their properties should interest rates rise. Around half of homes in the private rented sector are owned by landlords with buy-to-let mortgages.
Sir John Cunliffe of the Bank of England recently warned of a “spiral of house price declines” if a large number of buy-to-let landlords sell at the same
The Bank is concerned that mortgage lending for buy-to-lets has been too lenient. There has been a huge growth in loans to landlords. The total stock of banks’ buy-to-let mortgages is up 40 per cent since the 2008 crisis, compared to growth of just 2 per cent in owner-occupier mortgages. Buy-to-let loans now make up around 15 per cent of lenders’ mortgage books, compared with just 2 per cent in 2000. Widespread defaults on mortgages could affect banks’ stability.
Read more: Don't get burned by the buy-to-let boom
It’s also impossible to ignore the wider social context. The International Monetary Fund has previously warned that UK house prices are so high they pose a threat to the economy. The government is cutting tax breaks and limiting investment in residential properties, over fears that escalating demand from landlords has distorted the property market and pushed house prices out of reach for ordinary people.
WHAT WILL CHANGE?
Proposals put forward by the Prudential Regulation Authority, part of the Bank of England, says banks should assess buy-to-let mortgage applications under a stricter set of criteria. Lenders usually ask landlords to prove the rental income from the property will cover 125 per cent of the mortgage loan at a 5 per cent interest rate, for borrowing up to 65 per cent of the property value. For loans above 65 per cent of the property value, banks use a rate of 5.5 per cent to assess whether the landlord can afford the repayments, explains Ray Boulger of mortgage broker John Charcol.
Those levels will be raised to 5.5 per cent as standard. In addition, when deciding whether to award a mortgage loan, banks will take into account the costs of renting out the property and any tax liabilities connected with it. Lenders will also look at the landlord’s earnings, expenditure, living costs and their personal tax position.
The changes bring buy-to-let mortgages closer in-line with owner-occupier mortgages. In a way, the new regulation will set in stone a trend that’s already been underway at banks, says Boulger. “Lenders have been increasing their stress tests anyway. This will force the hand of those that haven’t,” he says.
It could open the door for more stringent affordability criteria. “This might be a first step and it does leave the regulators scope to increase it further,” Boulger adds.
If passed, the rules will add to a number of measures already announced by the government to discourage investment in residential properties. Buy-to-let landlords will have to pay an additional 3 per cent surcharge on each stamp duty bracket, while there have been cuts made to the previously generous system of tax breaks for landlords.
The rules are likely to have the biggest impact in London. Rental yields, or the amount of rent a landlord receives in relation to the price of the property, are low in London since house prices are so high. “In low yielding areas it is almost impossible to get 75 per cent rental income,” says Boulger. “In London it is going to be quite difficult to borrow more than 55 per cent [of the property price].” So these new rules won’t be much trouble for people who don’t need to take out large mortgages. But for smaller property investors who rely on high loan-to-value mortgages, it could be the nail in the coffin.
There’s a provision in the proposed rules which says landlords who are re-mortgaging will not have to undergo this additional stress testing. Sounds hopeful. Many London landlords invest in the property not for the rental income but for house price appreciation. They tend to re-mortgage more frequently as prices rise, and potentially the affordability criteria will not apply to them.
But judging by past experience, when similar rules were introduced for owner-occupiers, the big high street banks are unlikely to want to run two different systems. “It was just more trouble than it was worth for banks,” says Boulger. Smaller lenders may be willing to implement this rule, he says, but the larger ones are probably going to stress test all buy-to-let mortgages, re-mortgaging or otherwise.