New Stress-Tests for BTL Mortgages?

Almost two years ago, the Mortgage Market Review was introduced after several years of discussion and amendment. The legislation was first proposed in 2009, when it became clear that the existing rules had allowed the very risky mortgage lending that contributed so spectacularly to the global recession of 2007/2008. Taking effect on 26th April 2014, the new rules were designed to prohibit such ill-advised lending and thus, to help prevent future economic problems of the same scale.

Amongst other things, the MMR introduced the concept of mortgage ‘stress testing’. In effect, this meant not simply assessing the borrower’s ability to repay given the current conditions, but the ability to continue to repay should circumstances worsen. For example, could the applicant still service the mortgage if interest rates were to rise? Forcing lenders to ask such questions helped to limit the scope for reckless lending but, as an inevitable side effect, it also made it harder for first time buyers to secure a mortgage.

This is relevant to today’s property investors because the Bank of England is now proposing that similar measures be introduced to limit lending to buy-to-let landlords. The Bank’s Prudential Regulation Authority (PRA) is likely to be well aware of two key beliefs: firstly, that the government’s recent tax changes will limit the profitability of certain buy-to-let investments, and secondly that an over-inflated BTL market could lead to severe housing market volatility at some indefinable point in the future. With these concerns in mind, it is recommending that lenders introduce new stress-testing for investors.

According to the BBC, it is estimated that the new measures could see new lending on BTL mortgages fall by up to 20% over the next three years.

In essence, the new rules – if adopted – would oblige lenders to consider how interest rates might change over a five year period following the agreement of any mortgage – and to make their decisions accordingly. Likewise, they would also have to assess whether the applicant could continue to service his or her mortgage if interest rates were to rise by 2%.

The rules would also ask lenders to consider a landlord’s broader financial circumstances before deciding upon a mortgage offer. These circumstances could cover almost anything affecting the individual’s ability to pay mortgage interest – be that the presence of other debts, tax liabilities, the risk of voids or the costs associated with maintaining the new property etc. In cases where the landlord is relying on other sources of incomes to prove his or her ability to maintain steady mortgage payments, the lender would also be obliged to investigate those sources to confirm they are reasonable and reliable.

The proposals have entered the consultation stage, which will now continue until the end of June.

While this news might appear ominous, it is worth bearing in mind that the majority (around 75%) of all BTL lenders have already been adhering to these principles for some time. For them, the proposed changes would bring nothing new. However, the remaining 25% might well be forced to reduce the extent of their lending and it is here that the biggest market impact might be felt.

Should the PRA’s recommendations materialise, then there are good grounds for believing that total lending will fall. A Bank of England survey of the 31 top lenders reported a general expectation that the BTL market would grow by 20% per annum over the coming years. According to the Financial Times, the Bank believes “its measures will only have a slight dampening impact on the growth of lending, expecting that growth will now be restricted to around 17 per cent.”