PRA deadline for portfolio landlords and lending changes
The second roll-out of Prudential Regulation Authority (PRA) changes to buy-to-let mortgage underwriting must be in place by 30th September 2017. Much is being made of the extra underwriting measures for portfolio landlords, but more importantly, the way lenders approach buy-to-let lending may change.
The PRA is setting an expectation that the lenders they regulate should change the way they calculate the capital they need to hold against buy-to-let borrowing, which is a disincentive that may increase costs to landlord borrowers.
All the talk, at present, is around the extra administration of borrowing for landlords with more than three buy-to-let mortgaged properties, but what we aren’t hearing about is if or how lenders will change their strategy to accommodate this disincentive.
Below we cover both subjects. The extra underwriting measures will mean more admin for those borrowing where they have or will end up with four or more properties – painful but achievable, but we open the piece with a look at the change to lending.
Not all buy-to-let lenders are regulated by the PRA, we will monitor their position as it becomes clear.
Either way, borrowing may get more challenging for portfolio landlords, so if you are planning on adding to, or remortgaging, your portfolio get in touch with our team as soon as possible, so we can identify and secure suitable financing.
Disincentive to buy-to-let lenders
The final rule imposed on lenders, via the second phase of PRA underwriting changes, is that they have an expectation that the SME supporting factor included in the Capital Requirements Regulation of the Basel III banking regulation should 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 (Small to Medium Enterprises) 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 should not be applied to buy-to-let lending, the PRA is potentially making it less attractive to lend for this purpose, because it means that lenders will have to hold more capital against this type of lending. Holding a greater amount of capital has an associated cost to the lender.
The result may be that, in order to recoup the cost of holding additional capital, lenders increase the cost of lending to the customer, or they reduce the overall funding they lend via this avenue.
Extra underwriting measures for portfolio landlords
The changes we know more about are the additional underwriting measures for those defined as portfolio landlords, and one of the biggest lenders in the industry was the first to announce its approach.
Why is underwriting of portfolio lending changing?
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 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 are scheduled for a second-phase roll out, on 30th September 2017.
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:
- The rate of the risk of arrears increased as portfolio size grew
- Lenders already implemented specialist underwriting measures where portfolios exceeded a given size
- 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 will the underwriting of portfolio buy-to-let lending change?
From 30 September 2017, portfolio landlords will be subject to more rigorous checks from a lender when they remortgage or buy new property. This will inevitably mean requests for more information regarding their properties and could mean that borrowing becomes harder for them.
The types of information that the PRA suggest lenders should gather (as outlined in their Supervisory Statement) include, but are not limited to:
- the borrower’s experience in the buy-to-let market and their full portfolio of properties and outstanding mortgages;
- 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?
One of the sector’s biggest buy-to-let lenders, The Mortgage Works (TMW), has already outlined their approach to the new regulation; they are the first to announce their plans and as a result are outlined below.
Be aware that Commercial Trust works with a wide range of buy-to-let lenders whose approach, when announced, may differ from that of TMW.
Criteria: interest coverage ratio for portfolio cases will be 145%. Interest coverage ratio for Houses in Multiple Occupation (HMOs) will remain at 170% regardless of applicant’s tax status.
At lender decision (or agreement) in principle:
- Details of personal income will be required (this is commonly asked by other lenders already, but is a change for TMW)
- 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 two properties, financed by buy-to-let mortgages and you are applying to buy two 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.
- Three month’s bank statements for the applicant(s) and a property schedule of the products held within the applicant’s 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)
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.
This information should not be interpreted as financial advice. Mortgage and loan rates are subject to change.