Will PRA bring in new affordability rules?
- Published: Tuesday 01 December, 2020
- By: Commercial Trust
The Prudential Regulation Authority, or PRA, is the arm of the Bank of England which regulates a wide range of UK mortgage lenders.
This week they have published a report, on findings relating to the approach lenders are taking, for assessing affordability in the buy to let sector.
Concerns have been raised around the response lenders have made to affordability calculations, given recent tax changes. The focus of the PRA report is upon landlords who are higher rate tax payers, because they have been most significantly impacted by the tax changes.
PRA on lender assessments
Referring back to their 2016 document ‘Underwriting standards for buy to let mortgage contracts’, the watchdog highlighted that they expected lenders to have to adapt to interest rate increases.
The PRA has highlighted that the percentage at which lenders calculate affordability, for buy to let mortgages, may not have been adequately adapted to reflect recent tax changes.
These changes to Mortgage Interest Tax Relief were implemented steadily over the past 3 years and have little to no effect on basic-rate taxpayers.
The change comes when higher-rate taxpayers are assessed for affordability, on buy to let mortgages.
How is buy to let mortgage affordability assessed?
Mortgage affordability calculations use both a stress rate and the Interest Coverage Ratio (ICR) to determine if the deal is affordable for the applicant.
The stress rate is a hypothetical rate of payment a lender will use in the affordability calculation. It is a rate which is higher than the real rate of payment charged by the lender.
The ICR, as defined by the PRA, is “the ratio of gross rental income to mortgage interest repayments.”
By undertaking a calculation that is based on a higher rate of payment and requires the rent to exceed the mortgage payment by a percentage greater than 100% (often either 125% or 145%), the lender can assess if the mortgage remains affordable, should the applicant’s financial situation worsen for any reason.
Current and potential ICR assessments
Whilst basic-rate taxpayers can be assessed against the minimum ICR of 125%, the PRA states that this needs to be adjusted to 167% for high-rate taxpayers, to take the Mortgage Interest Tax Relief changes into account.
In the article, the PRA discusses that most lenders typically assess higher-rate taxpayers at an ICR of around 145%, some 22% away from where it would be, if the changes were enforced.
This means that lenders are accepting a lower net rental income, when it comes to higher-rate taxpayers.
They believe that, if all other aspects of the enquiry were equal, this assessment at a different rate would lead to riskier lending.
What does this mean for me?
In the report, it is acknowledged that the “overall quality of buy-to-let lending has improved since 2016. And tax changes introduced since 2016, including the MITR, have meant the buy-to-let market has been very subdued”.
At present, the PRA are monitoring this area and will continue to do so, with no changes being made as yet.
However, if the PRA comes to conclude that tighter affordability controls are required, the lenders that it regulates would have to act.
This could mean that, if you are a higher-rate taxpayer, applications for a buy to let mortgage may come with a heavier assessment, resulting in the amount you could borrow being lower than is currently the case.
The PRA does not regulate all buy to let mortgage lenders, so if changes were required, not all lenders would be affected.
The report also notes that higher rate taxpayers typically have higher incomes, derived from a wide range of sources.
At present, some lenders offer “top slicing” where, as long as rental income covers the mortgage payment, an individual’s surplus personal income is assessed against the additional percentage cover required in affordability calculations.
If tighter affordability calculations became a PRA requirement, PRA regulated lenders may look at this approach to affordability assessments.
This, in turn, may mitigate the impact of any changes, for those with adequate personal incomes.
Read the full article on the PRA website here.
This information should not be interpreted as financial advice. Buy to let mortgage rates are subject to change. Speak to our advisors for a mortgage illustration. Seek tax advice from a professional.