Tougher affordability rules for those seeking buy-to-let mortgages will take effect from January 2017, the Prudential Regulation Authority (PRA) has confirmed
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The new standards apply to PRA regulated firms carrying on buy-to-let lending that is not regulated by the Financial Conduct Authority. These standards follow a PRA consultation, published in March this year; and are designed to “bring all lenders up to prevailing market standards and guard against any slipping of underwriting standards during a period in which firms’ growth plans could be challenged by the changing economic landscape and the impact of forthcoming tax changes”, the regulator said.
The PRA will monitor the extent to which its new rules affect the buy-to-let lending market, and may formally review their implementation by firms early in 2018, it said.
A thematic review of the buy-to-let lending market by the PRA in 2015/16 found the risk of firms relaxing their underwriting standards on buy-to-let mortgages.
From 1 January 2017, lenders will be required to ‘stress test’ the impact on mortgage affordability of interest rates increasing to 5.5%, or by two percentage points, whichever is higher. The affordability assessment should also take into account the borrower’s costs, including tax liabilities, associated with renting out the property; and verified personal income where this is being used to support the borrowing.
Lenders will not be able to take into account any predicted increases in the value of the property as part of the affordability assessment, and will only be able to assume a 2% increase in rental income each year in line with inflation. The interest coverage ratio (ICR), which refers to the ratio of rental income to mortgage payments, should also remain above 125%, according to the PRA’s policy statement.
Firms will also be required to put a ‘specialist underwriting process’ in place for assessing lending to ‘portfolio’ landlords; defined by the PRA as those with four or more mortgaged buy-to-let properties. They will also have to put in place “adequate risk management and controls” specifically for buy-to-let lending. However, they will have until 30 September 2017 to make these changes.
The PRA’s policy statement also confirms that exceptions to the capital requirements rules, which are designed to boost lending to small and medium-sized businesses, do not apply where the business is a buy-to-let business.
In response to the consultation, the PRA has waived the interest rate stress test for loans where the interest rate is fixed or capped for five years or more. The new affordability rules will only apply to new buy-to-let mortgages, and not to re-mortgaging where there is no associated increase in borrowing, according to the policy statement.