In his Financial Stability Report, Carney said if mortgage interest rates increased by 300 basis points, the amount residential mortgage lenders stress owner-occupier’s affordability, nearly 60% of buy-to-let borrowers would see rents fall below 125% of interest payments.
The industry standard interest coverage ratio is 125%, which indicates the amount by which the rent received must cover the mortgage interest payment.
However, Carney said just 4% of recent owner-occupier borrowers would see their mortgage payments rise to about 40% of income in the event of a 300 basis point rise in interest rates. This is the level which the Bank said households are more likely to struggle to keep up with payments.
In its twice-yearly report, the FPC said that the increased vulnerability of buy-to-let borrowers to interest rate rises and income falls could trigger a large fall in house prices.
A survey carried out by consultancy firm NMG showed that around 15% of buy-to-let investors would consider selling their properties if the rental income no longer covered their mortgage interest payments. The findings also revealed a further 45% would think about selling up if property prices were expected to fall by more than 10%.
If investors reacted in this way the FPC said their behaviour could make a fall in house prices much worse which could be damaging to consumer spending and economic stability.
The governor has been vocal this year over his concerns that growth in the buy-to-let market and looser underwriting standards practiced by lenders may be harmful to the economy. The finger now appears to be pointed at smaller lenders accused of loosening lending policies by, for example, raising loan-to-values.
The FPC wants the Treasury to give it powers to order lenders to place limits on owner-occupier and buy-to-let lending through LTV ratios, debt-to-income ratios and interest coverage ratios.
The Treasury is planning to launch a consultation this year on whether it will hand the FPC similar powers over the buy-to-let market to those it already wields in the residential market. The consultation appears to be a formality, however, because George Osborne told the Treasury Select Committee in October that powers had already been granted, although no official announcement has been made.
Until it is made official the FPC said it stands ready to intervene if it believes it is necessary to protect the country’s financial stability and will be monitoring the market closely following the Chancellor’s tax announcements in the Summer and Autumn Budgets on Stamp Duty and cuts in tax relief.
Yesterday, Barclays increased its interest coverage calculation from 125% to 135% in a move it said would protect landlords from affordability shocks because of cuts in the amount of tax relief they will be granted.