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Industry in depth
Let to buy
26 May 2007
Mark Bergin looks at let-to-buy and the benefits this product type can have in today’s mortgage market
With the huge rise in buy-to-let in recent years, let-to-buy (LTB) almost seems to be the forgotten product in terms of column inches and consumer awareness. Yet, interestingly, LTB has never really gone away in terms of sales. There are no specific published market figures but anecdotally it’s fair to assume that LTB probably accounts for some 10 per cent of a niche lender’s total lending.
One possible explanation of why buy-to-let is a much more ‘fashionable’ concept than LTB is that the former was born at a time of soaring house prices and huge feelgood factor, whereas the latter was a product of one of the most depressed housing markets in living memory.
Mortgage professionals of a certain age will probably wince when they recall the situation that faced them at the beginning of the 1990s, with mortgage rates well into double figures, seas of ‘for sale’ signs and the term ‘negative equity’ entering the nation’s vocabulary for the first time.
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This stagnation in the housing market had a bad knock-on effect on the country’s social and work mobility – people were prevented from moving to a larger home to accommodate a growing family, for example. Or they were unable to move to a different part of the country to follow a job offer because paying rent for new accommodation on top of the mortgage on an existing home they couldn’t sell wasn’t viable.
Here comes the cavalry
Into this dire situation rode the metaphorical cavalry in the form of a few specialist lenders armed with the revolutionary LTB product. Suddenly brokers found themselves on the front line of problem solving for those clients whose situations had seemed almost hopeless.
People could then escape from their particular trap with a mortgage on their new main residence, while the mortgage on their existing property was covered by rental income. Like all great ideas, it was very simple and it worked.
Not that LTB was a magic wand to solve everyone’s problems, of course. A LTB arrangement was, and still is fundamentally a business opportunity in that the client is becoming a landlord. For the product to work, there had to be a genuine rental market for that property type in that location so the person moving on could have a reasonable expectation of letting their soon-to-be vacant property.
Now we fast-forward and pass through the mid-to-late 1990s, when the housing market was again buoyant thanks to more affordable interest rates and restored consumer confidence. By mid-2001, with interest rates touching a 40-year low, it was a case of lighting the blue touch paper and standing back. Average UK house prices have doubled in those few years.
Little surprise then that the negative equity busting LTB gradually fell from the limelight under a deluge of interest in buy-to-let. But the truth is that the earlier product is far from being a one-trick pony and now could be a great time for packagers and brokers to look again at the problem solving opportunities LTB offers.
It shouldn’t be forgotten either that today’s LTB product is more versatile than its ancestor in that the concept now has the added attraction of self-cert for those with complex income streams and also the possibility of flexible features. This is good news for investors coping with practicalities like refurbishing the rented property, or periods when it may be standing empty.
Centre stage
The first key market factor that could bring LTB back to centre stage is rising interest rates. The latest hike in May is unlikely to be the last one for 2007. This upward trend will be felt particularly strongly by those whose fixed rate deals are coming to an end, bringing an unpleasant surprise as their mortgage reverts to their lender’s standard variable rate and their monthly mortgage repayments leap upwards.
It seems inevitable that the rising cost of borrowing will at least dampen growth across the housing market. In turn this could dent the consumer perception created over the past few years that property prices will continue to rise regardless of basic economics. Should the market slow down or even see falling prices then people will tend to hold back on their purchases – with chains the inevitable result.
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That, of course, is where packagers, intermediaries and estate agents should consider LTB as a serious chain-busting tool – doing just what it was conceived to do, albeit now in far more benign circumstances.
The chain-breaking capability could become even more important towards the end of the decade when the Land Registry introduces its Chain Matrix system which will make an individual chain transparent to all parties, highlighting where properties are sticking.
Only the beginning
While buy-to-let is the current consumer investment vehicle of choice, LTB has attractive benefits for clients who are looking to move up the property ladder.
“We find that many clients are simply unaware that the LTB option exists,” says Phil Burke of Specialist Mortgage Funding. “The perceived risk of letting out the property you’re leaving is often seen to be lower than going the buy-to-let route, and that appeals to people who would welcome the investment but don’t see themselves as professional landlords. An added incentive for LTB is that generally speaking we can secure a slightly higher LTV than on a buy-to-let, so deposits on subsequent properties can be low.”
“One LTB option is called staircasing,” explains Simon Nicholson of Creative Mortgage Solutions. “A broker’s client takes out a mortgage on the property they are moving up to and lets out their existing property, so effectively the tenant covers the cost of that mortgage. When the time is right, the landlord moves up again using the same type of deal and then they have two tenants paying their mortgages on their two previous properties. Provided they buy each new property with a view to its future letting potential then they can continue to staircase and start to build a large property portfolio in their wake.”
Some will use the staircase effect to boost their retirement income, while a growing band of investors are using LTB to grow a portfolio of properties for a different reason, as Burke explains: “It’s clear that the first-time buyer problem isn’t going away for the foreseeable future. If the market isn’t finding solutions then parents are taking the situation into their own hands and creating what is effectively a private stock of homes for their offspring.”
That means instead of still living in the parental home into their early 30s, young people can move out into these other homes earlier and take over the mortgage which could - if their parents bought the property some time ago – be a lot smaller than if they were buying a similar property in the normal way. Effectively the rental income has subsidised a ‘cheap’ mortgage for the first-time buyer. If the rented-out property reverts to the young person’s main residence after more than three years as an investment, it will probably be subject to capital gains tax, so any client considering this arrangement should seek appropriate advice first.
Emerging roles
Another interesting solution for a similar issue is for empty nesters who have a large family home to rent out using LTB. They then downsize again, but there will be capital gains implications if the family home is rented out for more than three years.
Yet another emerging role for LTB is as part of a so-called ‘double deal’. In this scenario, a client remortgages their original property with buy-to-let and purchases their new main residence with LTB, both with the same lender. This is good news for the lender because they sell two mortgages instead of one, and, of course, the broker gets two lots of commission.
It is testimony to the fundamental ‘rightness’ of the LTB product that it is as much, if not more of a problem solver for your clients now than it was nearly 15 years ago. In fact, if the LTB concept didn’t exist, now would probably be the perfect time to invent it.
Will it, or wont it
Will it or won't it crash? That is the housing market question that everyone wants the answer to…if only I had a pound for every time! Even if we don't see a full on collapse there are already areas that are sluggish and this price stagnation could be the main reason why let-to-buy mortgages are having somewhat of a renaissance.
Unlike the much talked about and speculated on buy-to-let market, let-to-buy lending has been quietly smouldering in the background reminding us perhaps of the bad old days in the 1990's when the housing market took a tumble. In essence this type of mortgage gives the borrower the opportunity to use the rental income generated on one property to cover mortgage payments on a new investment. It is perceived as a more opportunistic type of borrowing that can cater for changing circumstances as borrowers do not need to release equity in their existing property or lose out on further capital value increments (or god forbid negative equity) to fund further investment.
History shows us that as a sales market falters, a letting market flourishes and we know that the rental market today still has a lot of value left in it. Buyers are leaving it later to get onto the property ladder (average age being 34yrs - I must go and buy one soon!), although this is usually through necessity rather than choice; tenants are signing up to longer lease agreements; and investors are committed to keeping their properties for at least 10 years.
Let-to-buy therefore presents an excellent opportunity for brokers to extend the options available to their clients in ways that perhaps they had not considered. How many times do your clients say they have found their dream home but can't sell the one they are in? Well renting it out to tenants could be an attractive alternative to losing the sale. Clients who are relocating may not want to sell-up entirely; at least not initially so renting out their first property in order to buy in a new area could prove to be ideal. Lenders criteria is often more lenient for let-to-buy clients as unlike the usual 15% deposit needed for a buy-to-let, they will take the existing property equity into consideration so only 5-10% may be required - so if clients don't have massive savings this could be just the ticket.
In terms of product choice most lenders who offer this type of mortgage have it as part of their core range. Any enquiries we have through the BDS New Business Team are generally prime rather than non-conforming and to be honest because of this most brokers will go direct. Eligibility is dependant upon the proposed rental income on the currently property and usually the existing mortgage is excluded from their calculations. This means than usual multiples and residential interest rates will apply - a win win all round!
So is there a catch? Well if there is I can't see one other than the fact that non-conforming business will not really get a look it here but I can see that if let-to-buy really takes off, there may be some scope for product development so watch this space.
What does the future hold
Let to Buy is a perfect example of using an existing concept, in this case Buy to Let, and giving it a new dimension. The facility is very simple and as the name suggests allows for a homeowner to let out his existing property in order to buy other property for residence or investment.
There are many reasons for clients to choose this step. A job move which requires an immediate start or difficulty in selling existing property are both excellent examples. People are more mobile today and will change their job a number of times during their lifetime. L2B enables people to move whilst keeping a preferred property at a location of their choice to return to at some time in the future. Other reasons could include the wish to release some equity to fund Buy to Lets or a new home or a means to build a residential investment portfolio over time.
Customers must contact their existing lender first as residential mortgages require lender consent if the property is to be let. Also, the insurer of the property must also be informed about the letting to give consent, endorse the policy for which there may an additional premium.
Most lenders will grant permission to convert a mortgage to Let to Buy but usually with some loading to the rate plus additional fees. However, this is not the only option. Owners should speak with a mortgage broker to see if better terms are available elsewhere. Not only may better terms be available, but the borrower may be able to release equity to put towards their new own home or to purchase additional investment properties. Borrowers should check if any early repayment charge is due if the existing mortgage is redeemed and to take this into consideration before moving their mortgage.
An existing lender will usually only need evidence that the rental income will cover the existing mortgage, whereas a Buy to Let mortgage may require rental cover of a minimum of 115% of the mortgage payment. A new lender considering a new owner occupier mortgage will consider the Let to Buy as self funding and will therefore lend up to their maximum income multiple on the new mortgage. Usually, lenders will increase the interest rate charged; may apply other charges, and will require that any letting is on the basis of an Assured Shorthold Tenancy agreement.
Demand for rental property is strong and is being fuelled by a shortage of property, inadequate new building starts, people delaying their first purchase until their 30s, an ageing population, immigration and the growth in single households. This trend is set to continue and with higher interest rates causing landlords to reduce Buy to Let purchases, we are likely to see supply not meeting rental demand resulting in higher rental yields over the coming year or so. Therefore with a slowing of the housing market due to higher interest rates, Let to Buy is likely to increase in popularity.