Navigating the BTL mortgage market

With significant changes to the buy-to-let mortgage market this year, Vidhur Mehra, Finance Director at Benham and Reeves Estate Agents looks at how this will affect landlords and property investors, both UK-based and overseas.

In 2014, the MMR (mortgage market review) became a headache for both property investors and lenders in the UK. The regulation changes required qualified staff to conduct stringent checks on mortgage affordability after the global financial crash (caused, in no small way, by mortgages being agreed without affordability checks). Borrowers’ finances came under scrutiny like never before as every element of their outgoings contributed to the affordability tests. For interest-only mortgage applications, a clear and guaranteed plan for repayment was the only way to secure a loan.

Three years later and ‘affordability’ is still the watchword. The Financial Policy Committee (FPC) has made a number of recommendations about the market and, specifically, it has directed the Prudential Regulation Authority (PRA) to make sure there are limits on buy-to-let mortgage lending in relation to loan-to-value (LTV) ratios and interest coverage ratios (ICRs).

It is a somewhat strange policy decision, especially in light of the government consultation that concluded that buy-to-let landlords play a positive role in the UK housing market, investing in housing stock and providing quality accommodation to those who, for many reasons, prefer to rent rather than buy. It is estimated that by 2025, just 40% of people living in London will own their own home.

Strange too, as it already follows a series of government moves to regulate the buy-to-let market, the latest being the cessation of higher-rate tax relief on mortgage interest for buy-to-lets from April 2017. The government, it seems, is worried that buy-to-let lending poses a risk to the financial stability of the UK – at a time when Brexit uncertainty is already causing financial instability.

Low-pound opportunities

The Financial Times points out that the fall in the pound’s value caused by Brexit is good news for foreign property investors: “Foreign buyers may never get a better opportunity.” Especially as the housing markets seems unaffected and remains a good investment. In fact, according to deVere Mortgages, there’s been a sharp increase in the number of overseas buy-to-let investors taking advantage of the pound’s low value to buy UK property.

Peter Izard, Business Development Manager for Investec Private Banking agrees:

“Investing in UK property has grown in popularity with international buyers in recent years; not only because property, particularly in London, offers investors safe title and historical long-term asset growth, but also the current added benefit of favourable exchange rates mean international buyers receive more for their money. For example, moving £1m to the UK for a property investment on the 23rd March 2017 would cost US$250,000 less than on the 22nd June 2016, and US$450,000 less than 1st July 2014. That’s a significant difference and one which means that keeping an eye on foreign exchange rates is every bit as important as keeping an eye on property prices.”

In addition, this year’s Budget saw two housing investment initiatives, funded by the NPIF, to try and maximise house building to keep pace with demand. In the UK, housing demand continues to outstrip supply.

New LTV ratios, interest coverage and lending dilemmas

Lenders assess a buy-to-let mortgage application based on the rental income and property value they are lending against. As expats and foreign investors have long been deemed higher risk, regardless of assets and income, UK lenders have always been cautious.

New rules however, have upped the ante. Lenders are now seeking borrowers to guarantee 145% of their mortgage costs from the rental income rather than 125% previously. Lenders are being required to assess borrowers’ ability to repay at a 5.5% rate when determining mortgage suitability (which suggests a Bank of England rate rise might be on the cards). In addition, from September this year, if an investor has a portfolio of four or more mortgaged properties, lenders will have to review and assess the rental income and mortgage terms on each individual property before proceeding to lend against a further addition to the portfolio.

Some buy-to-let lenders already restrict the number of buy-to-let mortgages you can hold with them to four or total borrowing to £2m. But that hasn’t stopped landlords mixing and matching lemortnders to get the best deal. The PRA rules state that if a landlord has four or more mortgages properties that lenders now look at a landlord’s full portfolio, not just the loans they have with them, before offering a mortgage to avoid ‘riskier’ loans.

As Hiten Ganatra, Director at Visionary Finance, points out, this doesn’t pose any real issue for specialist lenders:

“The mortgage market for foreign buyers looking to purchase UK property for own occupation or investment is very strong. A range of lenders, with rates starting from as little as 2.99%, can lend up to 75% of the purchase price. “For both buyer types, owner occupiers and buy-to-let investors, lenders assess the profile of applicants to establish that they are of good financial standing, have strong employment/self-employed credentials and most importantly are able to service the debt. For investment properties, whilst you will be achieving rental income which will be used to cover the mortgage payments, lenders will still assess your personal earned income to ensure the debt can be covered. “Some of the lenders allow for you to borrow the loan on an interest-only basis which means you will only be paying the mortgage interest cost on a monthly basis. This helps you to keep you monthly mortgage payments low and affordable.”

Lenders – your flexible friend

While the threat of extra paperwork may put off high-street lenders, there are those who have the flexibility to cater for portfolio landlords, both UK and overseas, and they are ready with the expertise to comply with the new regulations.

James Clarry, Head of Lending & Capital Management at Coutts comments:

“The housing market continues to face headwinds, with taxation changes and political uncertainty weighing on asset values. However, there are also opportunities. Firstly, sterling depreciation is attracting international investors who continue to see London as an attractive global centre. Secondly, in an environment of slowing growth and lingering Brexit uncertainties, the low-rate environment should continue to provide attractive conditions for borrowers. In response to the market challenges, many lenders have refocused their proposition to a core audience. However, in our experience, these are the conditions where a flexible lending offering is perfectly placed to support non-dom, international and UK clients with a tailored range of solutions through onshore and offshore experts.”

Un-limited options

The “range of solutions” Clarry mentions is significant. New rules from April 2017 mean that the tax relief on mortgage interest for buy-to-let loans will decrease to 20% by 2020. The Mortgages for Business survey found that this, alongside the stricter affordability requirements, would affect 60% of buy-to-let landlords. However, property held in a corporate structure, or limited company, is not affected by the tax relief changes, and the same report found that only a third of landlords had taken this route.

Ray Boulger, Senior Technical Manager at John Charcol comments that in addition to tax-efficient wrappers for portfolios there are other strategies:

“Recent regulatory changes imposed on buy-to-let lending by the Bank of England focus on stricter affordability assessments. The minimum interest used for the rental cover assessment must be 5.5%, unless the interest rate is fixed for at least 5 years. Lenders must take account of increased income tax liability where the investor is pushed into a higher rate by the income tax increases.

“Mitigating strategies include putting new buy-to-let investments into a limited company. This not only avoids the higher income tax charge but often allows a higher maximum loan. For example, rental cover required for limited companies is often still at 125%, whereas for personal investments lenders have generally increased it to 145%. “Increasingly, lenders are using the flexibility allowed for affordability assessments on 5 to 10-year fixes, in some cases even at pay rate. Therefore, choosing a 5 to 10-year fixed rate not only provides longer term interest-rate protection but also often allows a higher LTV as well.”

In addition, many financial institutions have already taken into account the new rules and are offering buy-to-let investors improved deals. New Street Mortgages, for example, has launched a new range of low-rate products for professional and portfolio landlords that are up to 80% LTV. The range includes loans to limited companies and the applications will no longer require the principal applicant to be an existing buy-to-let investor.

So what’s next?

In much the same way that property purchases rose dramatically just before the Stamp Duty changes for a second home kicked in, January saw a nine-year lending high before these changes to the mortgage market. T he Council of Mortgage Lenders too predicts £248bn of lending this year – up, albeit marginally, from last year’s estimated total of £246bn.

It is clear then that buy-to-let lending is still big business. Even though it is predicted to slow (the Council of Mortgage Lenders expects the number of buy-to-let properties purchased to fall from 100,000 last year to 85,000 this year and 80,000 next year), the remortgage market however, is expected to thrive, especially if interest rates look set to rise, as savvy landlords will be looking at refinance options to maximise their investments.

As Andy Knee, chief executive for LMS, comments: “Overall, the UK mortgage market is resilient and confidence in property remains high, buoyed by foreign investment and the collapse of the pound. We wait to see how the Chancellor responds to calls to revisit the changes made to stamp duty, widely held responsible for reducing deals at the higher end of the market. If he does, that will stimulate [buying] activity again.”

It is clear that property in the long-term is still a great investment however, there is a word of caution in relation to the buy-to-let mortgage changes. Now, more than ever, it is vital to confirm what the rental value will be before deciding to buy and invest. I was discussing it with a client who recently discovered this to their cost. They had been confident of the rental value, so much so, they didn’t confirm it with the valuer before buying. Unfortunately, the valuer had other ideas and projected the rental to be worth 30% less, thereby reducing the mortgage amount by 30%. Naturally this shortfall left the buyer in a difficult position. They had no choice but to pay for a second valuation providing the same information on the property that had directed their own projection of the higher rental value. This time the valuer concurred and the buyer was able to secure a mortgage for the amount they had budgeted for.

My advice is: be aware of the changes, shop around for the best loan options and, even if you know the market well, always consult an independent letting agent and an independent financial adviser before making any
property investment and mortgage commitments.