PRA upholds 5.5% buy-to-let stress test

Ryan Bembridge

September 29, 2016

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The Prudential Regulation Authority has confirmed that it will bring in tougher buy-to-let underwriting standards including a minimum stress test of 5.5% for the first five years of the mortgage.

In a policy statement this morning the PRA finalised the standards proposed in March, which also said lenders should consider how interest rates will move in the first five years of the mortgage.

However this won’t apply to mortgages fixed for at least five years.

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The interest coverage ratio tests and interest rate affordability stress tests will come into force on 1 January 2017 and the rest on 30 September 2017, in response to requests for a “phased implementation”.

Rent rises will also be taken into account with affordability stress tests.

Changes only apply to firms not already regulated by the Financial Conduct Authority.

Both the Intermediary Mortgage Lenders Association and lenders broadly backed the PRA’s changes to the market.

Peter Williams, executive director of IMLA, said: “IMLA welcomes the decisions published today in the PRA’s expectations for buy-to-let underwriting standards, which are broadly in line with industry’s expectations. They offer a sensible way forward, setting sector wide baselines while at the same time allowing for firm discretion to be exercised.

“We are encouraged that the new standards are to be implemented in a sensibly phased way over the course of the next year. In the interests of a stable market for buy-to-let mortgages and housing overall, this 12 month window should now be allowed to unfold free from additional change and upheaval.

“Some points of contention remain. There will be continuing concerns about the level playing field with firms outside of the PRA regime, though that is now clearly on the agenda of both the FCA and Bank of England. The use of a borrower minimum interest rate of 5.5% will also remain a source of tension, not least if interest rates fall again.”

Bob Young, chief executive of Fleet Mortgages, said: “While CP11/16 did cause some consternation in the industry, we at Fleet Mortgages are wholly supportive of these measures; indeed, to my mind, it is a positive to see all lenders having to raise standards and to be operating at levels which we believe we’ve been working at since launch.

“Anyone who has read CP11/16 will have understood this was less a consultation paper, more a statement of intent, and therefore we should not be surprised to see these results.

“This appears to be one of those rare occasions when we are acting now, rather than waiting until it’s too late – a case of the stable door being shut before the horse has bolted.

“Lenders have already been moving in a number of areas since its initial publication and we can expect those who do not meet these standards to have to move further, and relatively quickly, in the case of interest cover ratio and stress test changes which need to be implemented by the start of next year – the market norm is likely to be circa-5.5% at 145%. The PRA have allowed five-year fixes to remain outside these standards but I suspect if there’s a spike in five-year activity, they’ll move to include it.”

Matthew Wyles, executive director at Castle Trust Capital, said: “There were few surprises in the supervisory statement issued by the Prudential Regulation Authority today, but the published timeline should focus the attention of mortgage advisers who want to add value to their landlord clients and help them to make the most of their investment.

“With underwriting standards under the spotlight, we can expect a slight shift away from highly automated mass market buy to let factories and greater emphasis on understanding the circumstances and investments of individual landlords. As part of this, advisers should be exploring all of the tools available to them to help their clients achieve their lending objectives, and these may not always be the traditional methods they have used in the past.”

John Heron, managing director of Paragon Mortgages, said the lender was already well-aligned with the PRA’s requirements.

“A thorough affordability assessment, together with a full understanding of the characteristics of each property and landlord that we lend to has always been central to our approach and instrumental in maintaining our strong credit metrics,” he said.

“By requiring a more consistent approach across the market, the PRA should be able to ensure that the strong credit performance of buy-to-let lending is maintained and that lending remains sustainable.”

But he warned: “We would however, expect these measures to restrict the level of growth in the buy-to-let market going forward, by cutting out more marginal business. We also expect a larger proportion of the market to be specialist in nature, consisting of more professional portfolio landlord business. We believe that Paragon is particularly well placed to capitalise on the opportunities this presents given its unparalleled experience in this sector.”

David Whittaker, managing director of Mortgages for Business, said: “Today’s new underwriting standards from the Prudential Regulation Authority are in line with what we have been anticipating. We have been predicting a move to tougher stress tests by the end of the 2016 for some time, and it is positive to finally have a firm date by which they must be implemented.

“Nothing within the updated standards is a radical departure from many lenders’ existing best practices. However, those who have been slow to adjust to these standards may find themselves playing catch up with early adopters. The immediate focus for many lenders will be to adjust Interest Coverage Ratios on shorter-term products to 5.5% by the end of the year.

“The changes are likely to encourage more buy-to-let borrowers to move to a limited company model for buy-to-let investment. On top of these changes, the sector will also have to manage changes to landlords’ tax relief on mortgages over the next 12 months, which policymakers should bear in mind before looking to add further layers of regulation.

“From now on lenders and brokers will really have to ensure that they are educating landlords not only on the impact of stress tests but also the additional underwriting requirements that will bite on 30 September 2017.”

Richard Donnell, Insight Director at Hometrack, said: “The introduction of under writing standards for buy to let bring this small but important sector of the mortgage market in line with the rest of the market. The scale of the impact of this new policy on investors will depends upon how lenders set their interest cover ratios but the net result is that buy to let investors will need to inject more equity into their purchases from next year. A number of lenders have taken pre-emptive action ahead of this announcement and already adopted a 145% ICR and 5.5% stress rate, but others will need to develop their own policies.

“Our analysis shows that if these changes are implemented by lenders across the board then buy to let investors will need to inject a further 10% of the property price across half of rental markets. Together with the 3% extra stamp duty from April that means investors having to stump up 13% more equity to buy an investment property with a mortgage compared to the start of the year. A typical two bed property will require investors having to put in an extra £25,000 to £35,000 of equity for the mortgage – and even more in the lowest yielding and highest value housing markets. The net result will be a further weakening in demand for buy to let loans and a move by investors into higher yielding rental markets where the affordability test is easier to pass.”

 

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