Should landlords consider longer-term fixes that offer lower stress tests?
The introduction of stricter underwriting criteria has made life tougher for landlords taking out buy-to-let mortgages, but lenders may offer more flexibility to those locking into longer term fixed rates.
According to new Prudential Regulation Authority (PRA) rules, introduced in January this year, lenders must now take a more rounded approach to affordability to take account of the costs involved in running an investment property, not just the mortgage interest. They are also required to apply a 'stress test' of a minimum interest rate of 5.5% rather than simply using the current mortgage rate.
These stricter rules have been introduced to ensure that buy-to-let lending remains sustainable if interest rates rise in future, and that underwriting standards won't loosen over time.
The changes have fed through to the deals being offered, with many lenders now requiring landlords to receive 145% of their mortgage liabilities in rental income, compared to 125% previously. Many have also raised their stress rates from 5% to 5.5%.
The tightening of lending criteria has an impact on how much you can borrow. For example, if purchasing a buy-to-let property with £1,000 a month rental income, this would support a mortgage of up to £192,000, based on 125% at a stress rate of 5%. However, if these parameters are changed to 145% at 5.5%, the maximum amount a buy-to-let homebuyer would be able to borrow falls to £150,470.
It's worth noting that some lenders take a more graduated approach when it comes to buy-to-let mortgage applications. They may, for example, be prepared to lend more to basic rate taxpayers than higher or additional rate taxpayers because of the changes to tax relief on mortgage interest.
Others may be prepared to factor in any additional disposable income when assessing buy-to-let mortgage applications, enabling them to lend a little more than if they were to stick rigidly to the basic rental coverage approach.
A growing number of lenders are also offering lower stress tests on five-year fixed rate buy-to-let deals, typically 5% rather than 5.5%, which may enable borrowers to take out larger mortgages. This is because if the rate is fixed over five years, it's logical that there will be no fluctuation and therefore the stress test is less relevant than it would be for those on variable rate deals.
However, it's important for landlords not to choose a long term fixed rate deal just because it might potentially offer a bigger mortgage. A deal should only ever be selected on the basis that it is right for your individual circumstances. Most longer-term fixes have early repayment charges during the fixed rate period, which may not be suitable for some.
That said, it's worth noting that five year buy-to-let fixed rates are currently looking very competitive. Given so many changes to tax relief and lending criteria, they could therefore provide just the sort of stability and security that many landlords are looking for.