Buy To Let Lending Update
Published 15th August 2017
This article is an updated guide to Buy To Let (BTL) lending and criteria, as experienced by expert BTL specialists on the front line, covering all manner of topics, including how to cope with the changing landscape, how finance options have changed, and whether or not it may still be worth investing in a BTL property.
The BTL Market – What’s changed?
There has been a raft of changes to the Buy To Let (BTL) market in 2017, set to challenge many landlords in the months and years to come. Some of these changes have been and will be hard for investors and brokers to deal with, in particular the tax implications and lending restrictions, but this may open up new opportunities for those prepared to make the most of them, to whom BTL remains to be an attractive investment for longer-term returns.
We have also interviewed numerous experts on the future of BTL, as well as various other areas of housing and finance here if you’d like a read.
The BTL mortgage market has gone from making up approximately 6% of gross mortgage lending in 2008 to 20% in 2016. Many lenders catering for this growth compete both with better rates and a widening of criteria, allowing more people access to their products. This is usually great for investors and consumers, who are more able to find the finance they need and who benefit from great rates, but this often brings additional risk to lenders as they seek to lend to borrowers who would be considered more ‘niche’ or ‘specialist’.
This increased availability of cheap funding, as well as some staggering house price increases, has made BTL very attractive for investors, which has done little but push prices up further. In an attempt to bring house prices under control (amongst other things), the government has since imposed changes to the way landlords are taxed, and how they can borrow.
BTL Tax Changes (2017 Onwards)
We have written a comprehensive review of the recent tax changes to BTL property here, and an interview with many experts on the subject in our roundup of 2017 projections here, including comment from some accountants and tax specialists. For a brief overview, the main changes are as follows:
- Stamp duty reform
Those buying investment properties and second homes will be subject to paying an additional 3% stamp duty, where a £275k main residence would cost £3,750 in stamp duty, buying it as a second property would cost £12,000! This is one of the key levers the government is using to drive down demand in the rental sector, and is why investing in BTL property for short term returns is now far less lucrative.
- BTL Income tax reform
As it stands, landlords can deduct mortgage interest and other allowable costs from rental income before calculating their tax liability. In very simple terms if you had £500 rent coming in per month, and mortgage interest, management and maintenance costs of £250 a month, you would be declaring a profit of £250pm = £3,000 a year.
In a phased approach starting from the 2017/18 tax year until 2020/21, the amount of tax relief is reduced, and the gross rental income received without the ability to deduct the expenses, thus the £500pm is actually £6000 income per year, regardless of how much is paid out on various essential expenses.
This will have a huge impact on BTL investors, especially those in higher income tax brackets paying huge % tax on the income and potentially rendering the investment a close to nil return for some. We recommend you speak to your tax advisor/accountant about moving or purchasing properties via a Limited Company.
PRA Lending Changes
The Prudential Regulation Authority (PRA) have reviewed the BTL market and set in place new regulations (into force in January 2017), designed to help protect landlords from affordability issues in line with these new tax reforms.
These are covered in more detail below, but the three main changes to BTL mortgage criteria from 2017 are:
- Lenders must use a higher ‘stress rate’ for stricter affordability checks
- Lenders must look at the tax position of the applicants when assessing BTL affordability
- Stricter underwriting for landlords with 4 or more BTLs from October 2017
Is there a Future for the BTL mortgage market?
We certainly think so, as do lenders, who continue to invest in new products and systems, launching new rental calculators, promoting and competing for new limited company BTL business. With this brings greater opportunity for those prepared to step away from the high street and trust in more specialised lending solutions.
In our review of 2017 we interviewed numerous experts across the industry, including lenders and leading economists, and the overwhelming majority see BTL still has a place for investors. To summarise, it may be that those looking for short term capital growth have missed the boat, but with a continued lack of housing supply and increasing demand, property can only go one way and those in it longer term could well see some great returns, especially considering how low interest rates are in saving and other investments currently.
It’s likely that the serious investors will need to find more creative opportunities to make money in developments, which may bring about an increased need for specialist finance, and others may look to areas with attractive long-term prospects, such as those around Cross Rail and HS2. Others may also look toward Houses of Multiple Occupation (HMO) as another way to increase revenue and still shield themselves as best they can from the tax changes, by doing so inside a Ltd company, taking advantage of opportunity where traditional BTL landlords don’t have the experience / knowledge to jump in. Overall, it’s a challenging future for the BTL market, but one that still holds promise to those who are brave and smart enough to navigate the changing environment.
How to secure a Buy To Let Mortgage in 2017
So that’s the doom and gloom over, the good news is there are still many lenders looking to lend and even allowing people to benefit from these changes, by expanding and developing their criteria in reaction. We look at several strategies borrowers use to secure BTL’s in spite of the new rules, particularly those looking to increase their portfolio or buying property with a low yield.
How much can you borrow now?
This depends on numerous factors, making the affordability assessment even more complex. It's no longer just about rental income and deposit, you need to satisfy other lending and affordability criteria in order to accurately gauge an exact maximum loan size. As every lender is different in their underwriting this can be a real minefield! Thankfully we know what we're doing, and the experts we work with can calculate your affordability for you.
The new higher minimum ‘Stress Rate’
Lenders have always needed applicants to demonstrate a BTL mortgage is affordable, which historically was based on whether the monthly mortgage payments were adequately covered by the monthly rental income. A small number of lenders considered BTLs “self-funding” in this way, when the rent was more than 100% of the mortgage payment, but most required rent to be a minimum 125% of payments – an increase imposed to protect the borrower and ensure they had a monthly surplus of cash to cover maintenance of the property and mortgage payments during void periods between tenants.
Lenders mainly relied on an Interest Coverage Ratio (ICR) or ‘stress rate’ to determine the loan available for a given monthly rent received, and up until Jan 2017 they were permitted to set this rate themselves, so if they wanted to attract more BTL business they could, in theory, relax their ‘stress rate’ to offer larger loans against lower rental values.
As of January 2017 the regulator has imposed a minimum stress rate of 125%, calculated at a nominal interest rate of 5.5%, with many lenders increasing their rate to 145% or even 160% for the highest rate tax payers.
So, a mortgage of 100k with interest calculated @ 5.5%, would equal a monthly interest payment of £458, meaning the rent must be at least £573 per month (125%) for it to be considered affordable, or £664 for those lenders using 145% - a massive difference and highlighting why finding the right lender for you is now probably more important than ever before!
This will have a significant impact on those with low-yielding properties, often around London and the South East, as many properties will now fall short of the rental income required for the loan leaving investors either unable to buy the property with as much finance (and thus needing more cash), or existing landlords trapped in mortgages unable to refinance elsewhere.
How to calculate what you can borrow from Jan 17 onwards
If you want to know the baseline calculation for working out the loan you’re likely to get with a particular stress rate/rent, it’s as follows: £Loan required x Stress Rate (%) / 12 (months) x Coverage Required (%)
On a £100k mortgage, for example: £100,000 x 5.5% = £5500/12 (months) =£458.33 x 125% = £572.91
How Your Tax Band Could Affect Your BTL Borrowing
Adding the tax changes into the review by the Prudential Regulation Authority (PRA) means that lenders must demonstrate their stress rates are able to cope with changes to the applicant’s tax affairs. The PRA really want to know that applicants have sufficient income to maintain their mortgage payments if their tax bills are increasing.
Lenders are approaching this in one of two ways, either by implementing blanket calculations regardless of your tax bracket or using bespoke calculations for each customer.
High Street lenders in particular are using blanket calculations, so they are generally looking at a stress rate of 5.5% and a coverage of 145%. That means a rental of £500pm now only gets a loan of £75,000.
Other lenders have created bespoke calculators to assess the applicant’s current and future tax position (including factoring in the new BTL) and work out the maximum loan available. In practice this actually means that those earning more may borrow less, as their additional tax impacts BTL affordability to the extent that they may require up to 160% rental coverage. The £500 per month rent now only affords a loan of £68,000. However these bespoke calculations can be as low as 125% so they will give a better result for a lot of applicants, particularly over the blanket calculations.
Portfolio Landlords – Tougher underwriting
The final part of the PRA review that will have an impact on BTL mortgages is for people owning four or more BTL properties. This is where things become really clouded for BTL investors looking to expand their portfolio, as changes are in their infancy (they are being implemented in October 2017) and lenders are keeping their cards close to their chest. It is likely that lenders will assess the borrowers’ entire portfolio, calculating the total rental income and loan to value across all of the properties together, alongside any other income the applicant may have. This is certain to make applications much more arduous, making approvals and purchases of subsequent property less likely for many.
As you can see, it is becoming increasingly complicated to find the right BTL mortgage that will give you the loan you require, but thankfully the expert advisors we work with know the market inside out, and are on hand to guide you through the process.
You Can Borrow More With Longer Term Fixed Rates
Another option is to look for a fixed rate of 5 years or more. As the monthly mortgage payments are set for a longer period they are deemed more secure, and thus the PRA have allowed some lenders more flexibility with their stress rates, meaning they can offer larger loans when set up on a 5 year fixed rate when compared to a 2 or 3-year rate. Longer term fixed rates often come at an increased cost, but it could be the difference between getting the loan and not.
Increase Your Borrowing Capacity With Specialist Lenders
Mainstream Lenders – Not as straightforward as they seem
Although every lender is different in terms of criteria, the high street banks and their BTL lending arms have adopted a very generalised and cautious approach to BTL lending in 2017, and generally speaking, high street lenders all compete for similar business - straightforward, easy to process, low-risk borrowers.
For example, although one particular high-street lender may be more flexible with their stress rate to assess affordability for certain borrowers, they may also impose a higher minimum personal income threshold (applicants must earn in excess of £20,000-£25,000 in personal employed/self-employed income alongside the proposed rental income).
For this reason, many borrowers are declined by high-street lenders and can either wrongly change their plans to fit tighter criteria, or they can speak to an expert who will help them achieve what they are looking to do.
Specialist lenders - What can they do that others can't?
Some lenders are not bound by the PRA changes due to the nature of their mortgage book and how they’re funded. That means they can continue to offer BTL mortgage with lower stress rates, giving a larger loan for the same rental income. These lenders tend to work only with specialist BTL brokers who are used to qualifying, packaging and presenting these cases correctly, to ensure the application is processed in the correct manner. Below are some of the niche areas these specialist lenders can offer finance.
Specialist lender rates are more attractive than you might think.
Remember: Just because these lenders might be considered "specialist", doesn't mean they aren't reputable or well funded. They are made up of banks and building societies that you may not have heard of or recognise as big brand names, but are often big players in the broker-world, lending millions of mortgages each year. It's also important to keep in mind that actually they often offer great high-street standard rates for many, and in those ultra-specialist areas can offer rate-for-risk style lending with rates not far off the mainstream.
Using Your Earned Income To Increase Your BTL Loan
Some lenders allow borrowers to cover any shortfall in rental income required and the monthly payment, with personal income. For instance, if there is a shortfall of say £200pm in rental income, and the borrower is deemed to be able to afford the additional outgoing to bridge the gap, then the loan can still be approved despite not meeting traditional affordability. Of course in reality it is unlikely that the borrower will actually need to support the mortgage, this provides the lender with sufficient security. Not all lenders will allow this and of course additional underwriting is required, so applications can be much more complex and difficult to find. Typically, this type of underwriting is reserved for those with other incomes outside of property and investment, rather than professional landlords relying solely on BTL income.
Houses of Multiple Occupants
HMO's, as they are more widely known, are a great way for landlords to make the most of larger properties, by offering tenants a room for rent in a shared house that has communal areas. Each tenant has their own tenancy agreement, and usually their own lockable room or area of the property. For this reason, borrowing is considered much more specialist and commercial than a standard BTL with a single tenancy, and as such most mainstream lenders don't consider lending their BTL products on such properties. More on HMOs here.
Limited Company Buy-To-Lets
Buy to lets for Ltd companies have been available for some time in the mortgage market, but have taken off in recent months as investors rearrange their finances to bring about the best returns. As limited company BTLs are not bound by PRA guidelines, lenders have more flexibility with lending on lower yielding properties and clients can benefit from more generous affordability calculations.
Limited Company BTLs are available to those with adverse credit, no minimum incomes and people looking to purchase HMOs, in the same way as mainstream BTL deals, and the companies themselves can be either a purpose built property business or a business that usually trades in something else:
- Special Purpose Vehicles (SPVs)
These are Limited Companies set up just to buy/rent properties and can’t conduct any other business. No trading history is required as lenders appreciate they might have just been set up for purposes of the BTL mortgage being applied for. Instead of assessing a non-existent trading history, lenders will look at the directors/shareholders as applicants to decide whether the mortgage should be approved or not.
- Trading Limited Companies
We also receive hundreds of enquiries from directors of established trading companies that have a profitable history and want to use their profits retained in the business as deposit for a BTL property. Most brokers are unaware that actually there are a select number of lenders happy to grant mortgages to these companies despite the BTL investment not being their core business. It is possible for lenders to assess the creditworthiness of these companies as part of the application, but is also likely that at least 2 of the directors/shareholders are also part of the assessment process.
Changing Personal BTL Property In To A Limited Company
Because of the tax benefits, a lot of clients want to move their properties from personal name into a limited company. This is of course possible, however the transaction is one of sale & purchase rather than a simple transfer of equity into the company name, and as such there are a number of costs and tax issues to consider, including stamp duty and capital gains. It is important to speak to your tax advisor on this to determine the most efficient way of holding your property going forward, and for more info read what the experts say in our 2017 overview.
If you decide that changing into a Ltd company is the route you want to take, there are of course several lenders happy to accommodate this, with either a SPV or trading Ltd company as mentioned above. There is usually no need for the company to fund a deposit as part of the transfer, as this can be set up as a director’s loan to the company.
What’s the catch with Limited Company BTLs?
Although owning BTL property in Ltd company may sound like a great way to run your portfolio, there are a few things to bear in mind. Firstly, there are additional accounting costs to complete and file the limited company accounts and annual return to companies’ house, this is a cost to the business but it’s still a cost to factor in.
Secondly, there are fewer lenders and therefore less choice of mortgage products, and with less choice and the additional risk and cost of underwriting for lenders, the end result is often a slightly higher rate when compared to personal BTL mortgages (that said, as the market has grown competition has already driven down prices). There can also be additional limitations on lending criteria, such as loan sizes and/or minimum property valuations, postcode areas, property construction, and tenant type restrictions.
BTL Mortgages With Adverse Credit
Adverse credit mortgages for investors in buy to let property are more available than they have been for a long time. As lending criteria develops into new areas, more and more borrowers with bad credit can access finance, and at cheaper rates than you'd anticipate. For more detail on this view our BTL adverse credit section in this article.
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