1. Affordability testing
The affordability assessment of a buy-to-let loan will require firms to either use an interest coverage ratio test and/or determine whether personal income is sufficient to meet mortgage repayments (this can include income derived from the property). Lenders are not permitted to use equity in the property as a basis for an affordability assessment, nor take into account future increases in property prices.
2. Interest coverage ratio calculation
Borrower costs that will be taken into account by lenders include: management and letting fees, council tax, service charge, insurance, repairs, voids, utilities, gas and electrical certificates, licence fee, ground rent and any other costs associated with renting out the property irrespective of whether the borrower is an individual or a company.
In their assessment of a borrower’s minimum ICR threshold, lenders will be allowed to use a variety of information and data, including portfolio level data and data based on models.
The tax liability that is associated with the property will also be taken into account, including mortgage interest tax relief, the amount of which can be claimed by landlords is being reduced to the basic rate on a phased basis from 2017 to 2021.
Capital gains tax does not need to be included in the assessment of affordability.
3. Income affordability test
Personal income can be used by borrowers to supplement the rent in their affordability test. Wealth can also be included as a measure in the income affordability test.
Should personal income be used as the basis of an affordability test, lenders will have to conduct a detailed affordability assessment of the borrower taking into account income, credit commitments, essential expenditure and living costs.
4. Stress testing
Lenders will assume a minimum borrower interest rate of 5.5% during the first five years of the buy-to-let mortgage contract and must take into account the impact of likely future interest rate increases on affordability.
In cases where rental income is likely to partially mitigate higher interest rates in the future, lenders may take this into account, but the assumption for increases in rental income should not exceed 2%, in line with the government’s inflation target.
The PRA’s buy-to-let underwriting standards do not apply to non-PRA regulated lenders and lending to consumer buy-to-let customers. Equally, consent-to-let does not fall under the rules, whereby an owner-occupier on a residential mortgage applies to let their property temporarily. However, the PRA requires that existing consent-to-let agreements should be taken into account when assessing affordability for a new buy-to-let mortgage. Buy-to-let mortgage contracts with a term of less than 12 months will not be considered for the stricter affordability tests.
Corporate lending is also excluded from the rules, which, for the purpose of the PRA’s standards, is classified as lending conducted by firms’ corporate or commercial banking divisions which require specialist underwriting processes. This includes lending for mixed purposes, such as commercial real estate and where the purpose of the lending is investment or development finance.
Holiday lets, where a property is let out for a month or less, are also excluded.
Pound-for-pound remortgages are not affected by the changes. Lenders can exclude the arrangement fees, professional fees and administration costs when determining the amount of borrowing.
7. Porfolio landlords
Borrowers with four or more mortgaged buy-to-let properties will be classified as portfolio landlords and subject to specialist underwriting standards. However, firms may use their judgement when determining how to verify the number of mortgaged buy-to-let properties the borrower has.
Information requested by lenders in these circumstances could include: the borrower’s experience in the buy-to-let market and their full portfolio of properties and outstanding mortgages; the assets and liabilities of the borrower, including any tax liability; the merits of any new lending in the context of the borrower’s existing buy-to-let portfolio together with their business plan; historical and future expected cash flows associated with all of the borrower’s properties.
8. SME supporting factor
Lenders are prevented from using the SME supporting factor when conducting buy-to-let business, which reduces capital requirements on loans to small and medium sized enterprises by around 25%. There may be some limited circumstances where it is permissible for firms to apply the SME supporting factor to exposures secured on residential property that is let out, but not where the primary purpose of the loan is buy to let.
Firms will be required to implement the changes to interest coverage ratio tests and interest rate stress tests by 1 January 2017, with the remainder to be implemented by 30 September next year.