Phase 2 of PRA underwriting changes

Effect on the landlord community

Since the introduction in September 2017, Prudential Regulation Authority (PRA) underwriting changes have had a large impact on landlord borrowing.

Data from lender, Paragon Bank, shows that it has caused a steep increase in borrowers fixing their rates for longer periods of time.

The data shows that in the year prior to the changes, December 2016, there were 3,008 5-year fixed rate mortgages written.

This rose to 10,717 the following year to January of 2018, and has not slipped below the 10,000 mark since, even with the pandemic affecting borrowing.

We take a look back at the changes that were made below.

What changes were made?

The second roll-out of PRA changes to buy to let mortgage underwriting were put in place on the 30th September 2017.

This meant there were extra underwriting measures for portfolio landlords, but more importantly, the way lenders approach buy to let lending changed.

The PRA set an expectation that the lenders they regulate (despite buy to let not being a regulated form of lending, lenders themselves are largely regulated by the FCA) would change the way they calculate the capital needed to hold against buy to let borrowing, which was predicted to lead to an increase in costs to landlord borrowers.

A lot of the debate, at the time of introduction, covered the extra administration of borrowing for landlords with more than three buy to let mortgaged properties. But, there was a distinct lack of discussion as to if, or how, lenders would change their strategy to accommodate the disincentive.

Below we cover both subjects.

The extra underwriting measures meant more admin for those borrowing with four or more properties – painful but ultimately achievable. Of more concern at the time, was what impact the changes would have on lending. Albeit, not all buy to let lenders are regulated by the PRA.

Either way, borrowing got slightly more challenging for portfolio landlords, as an entire portfolio assessment became necessary for lending. However, much of the administration issues this caused, can be avoided by using a competent broker, willing to help with the paperwork.

Disincentive to buy to let lenders

The final rule imposed on lenders, via the second phase of PRA underwriting changes, was that they had an expectation that the SME (Small to Medium Enterprises) supporting factor included in the Capital Requirements Regulation of the Basel III banking regulation would not apply to buy to let lending.

“The what?” I hear you cry.

What is Basel III?

The Basel Committee on Banking Supervision was set up to improve banking on a worldwide scale in order to “enhance financial stability”.

Basel III is a framework aimed at achieving better and more resilient banks and banking systems.

The Basel III regulations made it likely that SMEs looking to borrow money would be negatively impacted, which was an unattractive prospect given the contribution that SME’s make at times of economic recovery. To mitigate that impact, an incentive was introduced which rebalanced the benefits of extending credit to SME companies.

The incentive comes in the form of a provision that allows lenders to apply a preferential ‘supporting factor’ to the risk weighting applied to capital exposure to SMEs; this supporting factor took effect on January 2014.

The potential impact of this change

By setting an expectation that this supporting factor would not be applied to buy to let lending, the PRA potentially made it less attractive to lend for this purpose, because it meant that lenders have to hold more capital against this type of lending. Holding a greater amount of capital has an associated cost to the lender.

In order to recoup the cost of holding additional capital, lenders could have increased the cost of lending to the customer, or reduced the overall funding they lent via this avenue.

Overall, we have found that the market remained largely the same, however some lenders introduced portfolio-specific products at slightly higher interest rates.

Extra underwriting measures for portfolio landlords

What was clear though were the additional underwriting measures for those defined as portfolio landlords, but, each lender took a slightly different approach in its interpretation of the rules.

Why did underwriting of portfolio lending change?

All of the changes to the underwriting of buy to let mortgages by the PRA came about after a review in 2015/16 of standards across the lender marketplace.

From 1st January 2017 tighter checks on interest coverage ratios and interest rate affordability were implemented with PRA regulated buy to let lenders.

Changes to the underwriting of portfolio lending were subsequently rolled out in a second phase, from 30th September 2017. These changes included applying interest coverage ratios and maximum LTV’s to the entire portfolio, not just the subject property

Having assessed the nature of buy to let portfolios, the PRA concluded that their complicated financial structure and variety of associated risks warranted special underwriting measures aimed at helping to protect the borrower from financial vulnerability.

How does the PRA define a “portfolio landlord”?

You may think of portfolio landlords as those with tens of properties, however, the PRA defines portfolio landlords as those with:

“…four or more mortgaged buy to let properties across all lenders in aggregate”

Source: Chapter 3, point 3.1. “Policy Statement | PS28/16. Underwriting standards for buy to let mortgage contracts. September 2016”

Why did the PRA define portfolio landlords as those with 4+ properties?

The PRA arrived at this definition having analysed research that showed:

1. The rate of the risk of arrears increased as portfolio size grew
2. Lenders already implemented specialist underwriting measures where portfolios exceeded a given size
3. The significant impact of changes in personal tax upon landlords

During the consultation period for the legislation, respondents felt that a definition based on number of properties alone was not necessarily a true reflection of a complex portfolio situation.

The response from the PRA placed responsibility for any further criteria, to define portfolio landlords, in the hands of the lender.

How did the underwriting of portfolio buy to let lending change?

From 30 September 2017, portfolio landlords have been subject to more rigorous checks from a lender, when they remortgage or buy new property. This inevitably meant requests for more information regarding their properties.

The types of information that the PRA suggested lenders should gather (as outlined in their Supervisory Statement) included, but were not limited to:

• The borrower’s experience in the buy to let market, their full portfolio of properties and outstanding mortgages and rent received;
• The assets and liabilities of the borrower, including any tax liability;
• The merits of any new lending in the context of the borrower’s existing buy to let portfolio together with their business plan; and
• Historical and future expected cash flows associated with all of the borrower’s properties.

What does this mean in real terms with lender applications?

The reality is that lenders are very much still willing to lend to portfolio landlords – this is a positive and lucrative channel of lending.

The will simply apply a background stress test to the portfolio to ensure that the portfolio is self-financing. Some lenders may also apply a minimum income requirement to portfolio landlords.

At lender decision (or agreement) in principle:

• Details of personal income will be required (this was commonly asked by other lenders already)
• Details of the total number of buy to let mortgaged properties owned by the applicant at the completion of the product being applied for will be used to identify whether they are categorised as a portfolio landlord.

(This means that if you currently own three properties, financed by buy to let mortgages and you are applying to buy one more, your total at completion would be four mortgaged properties and thus you would be categorised as a portfolio landlord.)

• Where applicants are categorised as portfolio landlords further details regarding total value, rental income and outstanding mortgage balances owed on the portfolio.

Further information may also be required, including but not limited to:

• Proof of income
• Asset and liability statement
• Business plan (comprising details such as length of property ownership, current and future portfolio management approach)
• Property schedule (if not already provided)

If you would like the team here to take a look at your current or planned buy to let borrowing, do get in touch, we would be delighted to help.