Buy-to-let reforms should reflect wider market conditions, lenders say
Published: 29 June 2016 | Author: Bernard Clarke
In our response to the consultation by the Prudential Regulation Authority (PRA) on underwriting standards for buy-to-let mortgage contracts, published today, we urge the authorities to take into account the wide range of regulatory and fiscal changes already affecting the sector.
Firms have progressively tightened their lending criteria in response to a range of measures affecting the sector. These include the introduction of the stamp duty surcharge on additional properties, limits on mortgage interest tax relief and the likelihood that the Financial Policy Committee will be given powers of direction over buy-to-let lending.
On top of this, firms may also adjust their lending plans in response to the EU referendum result. As the industry continues to respond to these headwinds, we believe there is a risk that the PRA’s proposals could magnify the effects on the buy-to-let sector. It is possible that the cumulative impact of intervention targeted at the buy-to-let sector could affect its strength and sustainability.
We also reject the argument that it is only possible to achieve further growth of the buy-to-let sector by relaxing underwriting standards and thereby increasing prudential risks.
Levels of buy-to-let arrears are currently little more than a quarter of those in the residential mortgage sector – which are themselves near an historic low point. And even though lenders do not extend the same levels of forbearance to landlords as they do to residential borrowers, fewer than one buy-to-let property in 2,500 is taken into possession.
Our response sets out our views on a range of issues, including assessing affordability for buy-to-let borrowers, interest rate stress testing, alignment with existing regulation governing residential mortgage lending, and the timetable for implementing new rules.
We welcome the PRA’s proposals to give lenders a degree of flexibility in interpreting their responsibilities for upholding prudential standards. We believe that, in a competitive market, regulators should not impose unnecessary restrictions affecting different commercial approaches taken by individual lenders – as long as this does not create prudential risks.
The scope of regulation
In its consultation, the PRA accepts that its proposals should not apply to buy-to-let customers who are simply remortgaging and, in doing so, are not increasing the size of their loan. We support this approach, and want to ensure that existing borrowers are not unnecessarily prevented from remortgaging to a better deal when there is no extra risk involved. We would urge the FCA to make it clear that this should apply to product transfers with the same lender, as well as remortgaging to a new firm.
Additionally, we recommend that the PRA’s proposals should not apply in cases where a customer in the process of remortgaging, wants to add a small sum to the amount borrowed to cover fees or to carry out repairs or improvements to their property.
The PRA’s proposals should also acknowledge that landlords have a range of options to fund the purchase of property, which includes buy-to-let borrowing but also encompasses corporate finance, and a combination of the two. Although the PRA’s consultation refers specifically to buy-to-let mortgage contracts, we would welcome an explicit statement from the regulator that purchases funded by corporate finance are excluded from its measures.
The PRA’s proposals would disproportionately affect a small number of firms who lend to high net worth clients. In our view, high net worth customers should be defined as those with a net annual income of more than £300,000, or assets worth more than £3 million, which would mirror the definition applied by the FCA. When these customers take out buy-to-let mortgages, their borrowing may be backed by personal guarantees or supported by collateral in addition to the property against which they are borrowing.
Lenders in this market are also in many instances too small to be significant from a macro-prudential perspective.We therefore suggest that lenders advancing fewer than 100 mortgages a year (on a rolling basis) exclusively to high net worth clients should be excluded from the proposed regulations.
We welcome the PRA’s proposals to allow lenders to decide whether to assess affordability by comparing the cost of mortgage interest payments either to rental income or to the borrower’s personal income, or a combination of the two. Individual firms have developed their own approaches to this, and we believe that this variety is an important feature of a competitive market.
Different approaches to assessing affordability mean that there is greater potential for the industry to meet the needs of different customers. As long as there is no greater risk, the freedom of firms to innovate and to adopt different approaches provides choice – and can make an important contribution to the development of best practice.
The PRA has sought to develop a standard set of variables – including the borrower’s income, expenditure, tax liabilities and credit commitment – that a lender should take into account in assessing affordability. It is important that this approach should not be unnecessarily prescriptive.
We have suggested that lenders should be able to develop their own models, taking into account relevant factors. Such an approach could allow lenders to assume, for example, that all landlords are higher-rate taxpayers and that there are accepted overheads associated with owning a property, rather than assessing affordability based on the unique circumstances of each individual borrower.
We welcome the PRA’s decision not to provide guidance on loan-to-value requirements, as existing proposals already provide adequate micro-prudential safeguards.
We also believe that requirements for assessing affordability also need to be sufficiently flexible to ensure that high net worth borrowers do not encounter unnecessary restrictions. We urge the PRA to reflect the general approach taken by the Financial Conduct Authority in the development of its lending rules, which allows borrowers with significant assets to use these, as well as their income, to guarantee their mortgage.
Interest rate stress testing
The PRA expects firms to apply a stress test to the affordability of borrowing rates that reflect prevailing market conditions but could also rise by at least two percentage points above current levels, as the Financial Policy Committee recommends. We do, however, question the logic of also testing affordability at an arbitrary minimum rate of 5.5%.
Lenders welcome the PRA’s view that stress testing of affordability against higher rates is not necessary for borrowers with mortgages which have a fixed-rate term of at least five years. Such an approach would align buy-to-let borrowers with residential mortgage customers covered by the FCA’s conduct of business rules. Applying more stringent requirements for the stress testing of affordability for buy-to-let customers would be inequitable and illogical.
We would also welcome confirmation by the PRA that lenders should be able to factor in future rent increases when assessing affordability. If lenders are expected to build into their calculations the effects of higher interest rates on the costs of running their businesses, it is also reasonable that they should be able to anticipate higher rental income. In many cases, rent increases are already written into the contract between landlord and tenant.
Landlords with large portfolios
We would like to understand more about the PRA’s proposals for “portfolio buy-to-let landlords” – defined as those with four or more properties funded by a loan – and the regulator’s view that this group has a higher rate of arrears than those with fewer properties. Only a very small proportion of buy-to-let mortgages fall into arrears and in most cases this is a temporary state of affairs, from which the borrower is able to recover.
We would like to see further analysis to understand the nature of any correlation between cases of arrears and the number of properties owned by the landlord. It may be that other factors – like the type and location of properties in the portfolio, or the landlord’s business model – contribute to a higher level of arrears.
There may also be a need to consider carefully the definition of a portfolio landlord. How, for example, should we treat landlords who own fewer than four properties as individuals but also invest jointly with others in additional properties?
The timetable for implementation
Finally, it is important that the PRA sets out a clear timetable for implementation of its measures. Lenders will need to have sufficient time to make adjustments to the way in which they run their businesses. Firms will need to make changes to systems, recruit and re-train staff and meet new reporting requirements.
Different aspects of the regulations may also take different amounts of time to implement. It may be possible, for example, to introduce new rules for assessing affordability and interest rate stress testing in a relatively short period. But other regulations, including those affecting landlords with portfolios – as well as systems changes that might be needed to lenders’ business – could take longer to implement.
We would like to discuss the details of a timetable for implementation with the PRA, and would also urge that there should be transitional arrangements covering loans that are in the pipeline during the implementation period.
- Our most recent data showed a fall in buy-to-let lending in April – following the introduction of the 3% stamp duty rate for purchasers of second properties at the start of that month. As might have been expected, there was a bigger fall in buy-to-let lending for house purchase than for remortgaging.