This week, we’re handing over the Optimise Accountancy blog to Property Solvers Investor Services – Ruban Selvanayagam, who is continuing his serialisation here of his recently-published Ebook called ‘The Professional Buy-To-Let Property Investors Ebook’ for readers.
The Ebook carries out a thorough review of the property investment sector in the UK, highlighting new legislation to be aware of:
- PRA criteria explained in full
- surviving post-Section 24
- due diligence toolkits
- rental market research
- management tools to utilise, and much more.
For this week, Ruban is explaining the PRA criteria in full:
“The second chapter of the Buy-to-Let Property Investor’s eBook explores the core issues surrounding the Prudential Regulation Authority (PRA) buy-to-let lending standards.
How buy-to-let lenders will ‘stress-test’ your mortgage application
Formally introduced in January 2017, the policy documentation explains how the revised criteria aims to “prevent loosening in current industry standards for buy-to-let underwriting, curtail inappropriate lending, and reduce the potential for excessive credit losses”.
These stricter requirements ultimately mean that, to meet stress tested debt-servicing requirements, investor landlords will need to commit additional sums of equity to secure financing.
Broadly speaking, alongside a feasibility analysis related to the merits of the buy-to-let property being collateralised (i.e. confirmation that the deal ‘stacks up’), affordability assessments will also closely scrutinise an investor’s own personal financial circumstances more than ever before.
Landlords that have already purchased property through Limited company structures may be accustomed to the extra underwriting processes – some of which have been briefly summarised below:
- Information regarding personal, pensions, savings, investments and company dividend income;
- At least 2 years of SA302 returns (via the HMRC) will be required;
- Lenders will need an understanding of the financial mechanics of existing portfolio holdings by means of requesting information on existing loan to value (LTV) ratios, bank statements, Assured Shorthold Tenancy (AST) agreements and other relevant documentation;
- Lenders will require a comprehensive understanding of other credit commitments (in addition to mortgage/secured borrowing) that will continue after the buy-to-let mortgage contract is granted. These will include unsecured loans, vehicle finance, and credit cards;
- Lenders will assume a reasonable level of future rental increases when assessing affordability that would mitigate interest rate rises. However, it is assumed that increases in rental income should not exceed 2%, in line with the Government’s inflation target as measured by the 12-month increase in the Consumer Prices Index (CPI). The PRA will be monitoring the calibration of the stressed rate expectations to ensure “ongoing appropriateness”;
- Lenders will need further assurance that the income derived from the property is sufficient to support the monthly mortgage interest. Mortgages will therefore be stress-tested at higher levels than the actual interest rate borrowers will pay once the loan is in place. At the time of writing, the notional default pay rate is set at 5.5 percent with a 145 percent Interest Coverage Ratio (ICR). As an example, a property earning £6,000 gross rental income per annum using this underwriting criteria would effectively need to demonstrate a £20,765 extra borrowing requirement relative to the pre-January 2017 calculations (five percent pay rate with a 125% rental cover).
Buy-to-let lenders are also likely to examine landlord’s refinancing risk at the end of the fixed/capped period, market expectations (including the future effects of Section 24 of the Finance Act 2015), any prevailing Financial Policy Committee (FPC) recommendations or directions, amongst other factors.
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Lending to portfolio landlords (defined as those with four or more buy-to-let properties) will be assessed using specialist criteria.
If you fall into this category, ensure you are prepared to outline your experience in the buy-to-let sector, assets/liabilities (loan to value ratios), cash flow forecasts, projections, and an overall business plan.
Whilst the new rules will not affect borrowing or refinancing in a Limited company capacity (as any associated Directors will not be affected by the income tax changes), we are advising investors to be mindful of the fact that the over-arching aim of the PRA is to control speculative lending, regardless of how property is acquired.
Therefore, it would be a reasonable expectation that similar affordability assessment criteria will be applied, if they are not already, by much of Limited company buy-to-let lenders in the short to medium term.
Nonetheless, it is well worth noting that these new underwriting standards will not apply to borrowers looking to remortgage on a ‘like-for-like’ basis (i.e. no additional borrowing).
The PRA regulations come part of a wave of unprecedented changes that buy-to-let investors, both novice and experienced, need to be aware of moving forward.
The report also contains a close analysis of the implications of Section 24 of the Finance (No. 2) Act 2015, over 230 modern due diligence and trade body tools, a detailed breakdown of the most efficient way to acquire property using a Limited Company (SPV) structure, plus a number of other relevant topics.
Please also access our Buy-to-Let Investor’s Financial Calculator – built with modern-day professional investors in mind – which will facilitate a more judicious approach to your appraisal process.”
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