Nightmare Before Christmas for Buy to Let borrowers?

As each day of December progresses, some of the doors on your “Buy to Let” Advent Calendar may no longer open. You need to act now if you don’t want to end up saying “Bah humbug!”

This is because the rules on Buy to Let lending are changing.  While this may possibly be good for the market long term it may give you a problem in the short term if you have not planned for it and need to raise funds quickly.

Since March 2016, the Buy to Let industry has been adapting to proposed changes by the Prudential Regulation Authority (PRA) and these have evolved into a new Buy to Let regime that became statutory in September 2016.

In a nutshell, the new rules put a far greater responsibility on lenders to assess ‘affordability’ in the Buy to let process.

That means making sure that all lenders consider personal earnings, future interest rates, taxation, landlord expenditure etc. These things have always been considered but we expect them to be looked at more closely going forward. Buy to Let’s just got more complicated.

Two main things will occur from January 2017 at the latest.

1. Lenders will be required to assess affordability for personal borrowers based on the new Buy to let taxation rules. These taxation rules basically are phasing out the benefits of tax relief on mortgage interest payments and will therefore incrementally eat into the net profits of landlords.
2. This combined with the need to allow for interest rate increases and other costs has led to changes in the way lenders will stress test rentals on Buy to Let loans and from January this will change to a norm expected to be something like this;

• 145% of rental stress tested at an interest rate of 5.5%
• Compared to current stress tests which have are often at an interest rate of 125% of 5% but can be as low as 125% at 3.89%.

So, what could this mean in practice?

Let’s say you own a Buy to Let in your own name that is worth £300000, you owe £150000 on it and you receive rent of £1200 pm. You want to raise an extra £40000 to put down as a deposit on a new buy to let for a property worth £180000 which would provide rental of £700 pm

Now at this moment you could, with many lenders, raise

Existing property (£1200/125%)x 12(months) /5% =£192000 giving you spare cash of £192000-£150000=£42000

New property (£700/125%) x 12 (months)/5%= Loan of £134400 + £42000 = £176400 towards buying new property

But from January, so in effect from mid-December once you factor in underwriting etc.the above calculations will have changed to this;

Existing property (£1200/145%)x 12(months) /5.5% =£180564 giving you spare cash of £180564-£150000=£30564

New property (£700/145%) x 12 (months)/5.5%= Loan of £105329 +30564= 135893 (A shortfall of about £15k)

You can see from the above example that the new lending calculation alone will reduce the amount you can borrow in an average situation from January.

Further changes are also in the pipeline and will be in place by September 2017 at the latest and these will involve lenders evolve the detail of how lenders stress-test your overall affordability and making sure the exposure on your whole portfolio does not breach their new calculations.

There will be invention, and there is always competition, so people will find ways to do business but the above are still very deep changes and will impact massively on the market.

Why did the Government do it?

You may wonder why the Government would target this market and what is the pension funds of many people with the twin pincers of taxation and regulation? We think there are practical reasons plus a fiscal benefit to the Government.

From a practical point of view this new Buy to Let model is moving in line with residential lending and closer to the European model, and there has been no U-turn despite the decision on Brexit.

It is suggested that by restricting Buy to Let demand, first time buyers will get more of a look- in as enthusiasm for the sector dampens and property supply increases. Shares and gilts may also get a boost as money moves from property to different asset classes.

A weaker pound may on the other hand bring back foreign investors to compete with UK buyers for those properties in the most attractive locations, with London as the obvious hotspot.

One can also sympathise with the regulatory idea that tightening up on affordability will make the market more stable by preventing irresponsible borrowing and lending. Whether Buy to let borrowers and lenders have been irresponsible is a different point. You could argue that it is business and all parties have behaved as such.

HMRC may have long been concerned that they are not benefitting fully from the Buy to Let market. They now have a more aggressive tax policy that may force many investors to consider either switching over the next few years to a limited company wrapper paying more income tax or selling up completely.

So, those Buy to Let investors who have mortgages will now collectively pay more tax as they can no longer offset all their interest costs.

This in turn will surely generate more sales which in turn should result in more short term Capital Gains Tax receipts and Stamp Duty revenues.

The property market is an important contributor to government coffers. It is also a crucial part of the economy. It impacts collective affordability but it also creates sentiment. If people feel well off they spend more. This can be important for growth. It is not surprising that managing the mortgage and property market has become a key strategy for the government and the Bank of England.

We don’t know how the new Buy to let world will be in detail yet. Not every lender falls under the same regulator. Even those that do which is the majority may be able to offer friendlier conditions to customers just switching loans rather than capital raising or purchasing. It is not yet clear where the lines will be drawn between individuals and limited companies. The detail is still to emerge but what we do know is that landscape will be very changed.

If you need to review your buy to let options, please contact us or call 0207 580 1555. If you have an urgent need it is probably best on this occasion not to wait for the January sales!