Up until 2017, almost everyone could go happily about their daily lives without being aware that mortgage lenders are regulated by an arm of the Bank of England called the Prudential Regulation Authority (PRA).
Suddenly though, that seemingly arcane bit of regulatory trivia became highly relevant to property investors – because the PRA issued new guidance about how mortgage lenders should assess potential loans.
The guidance fell into two main areas, which was implemented in stages:
- “Rental cover” stress-tests
- Additional tests for “portfolio landlords”
Let's take a look at each…
Prefer to listen instead? Listen to my interview with mortgage broker Simon Allen…
Rental cover requirements
Most buy-to-let lenders are regulated by the Bank of England’s Prudential Regulation Authority (PRA), who started insisting at the start of 2017 that when making a loan, the rent must cover at least 145% of the mortgage payment when the interest rate is at least 5.5%.
The calculation to work out how much you can borrow based on any given rental figure is: Annual rent / 5.5% / 145%
Effectively, the result of this is that each £100 of monthly rent supports about £15,000 of borrowing.
Let’s say you buy a £100,000 property with a mortgage of £75,000.
Monthly interest payment at 5.5%: £343.75
Interest payment x 1.45: £498.43
The rent therefore needs to be at least £498.43 in order for you to get the £75,000 loan. If the rent is lower, the amount you can borrow will be reduced.
In reality, the 145% requirement isn't set out firmly: the PRA has just said that the minimum should be 125%, but lenders should also take into account the borrower's future tax liabilities. This means that in practice, most lenders are applying a level of 145% – but some will stick with 125% or split the difference at 135%.
There are some types of lending that these rules don't apply to. Those are:
- Mortgages for limited companies
- Bridging lending
- Commercial or semi-commercial property
- Holiday lets
- Any loans with a fixed term of five years or longer
You also don't need to worry if you have mortgages that you took out before January 2017 which now wouldn't meet the new criteria if you were to remortgage. The PRA didn't want to create “mortgage prisoners”, so it excluded remortgages from these requirements – as long as you're not increasing the loan amount. In other words, like-for-like remortgages are fine – but if you want to raise more money against an existing property, the new rules apply.
Rental cover cap v LTV cap
What this all means is that the loan-to-value (LTV) is no longer the only test of how much you can borrow: the maximum you can now borrow the lower of the LTV cap (e.g. 75%) or the rental cover cap.
In general, I don't worry about this too much: if you're anywhere near failing the lender's rental cover test, the property will probably lose you money anyway.
Looking at the example above, imagine your actual rental income was £550 compared to the lender's requirement of £498. That would only give you £52 profit per month – and that's assuming no maintenance costs, management fees, service charges, voids, and so on.
Yes, in reality your interest rate will likely be lower than 5.5% at the moment – but that won't always be the case, and I believe you should stress-test any investment up to at least 7% anyway.
Portfolio Landlord rules
From September 2017, the PRA has also required lenders to ask additional questions of “portfolio landlords” when issuing new loans.
The definition of a “portfolio landlord” is someone with four or more mortgaged properties.
- Own three investment properties? You're not a portfolio landlord.
- Own five investment properties, but two of them you own outright? You're not a portfolio landlord.
- But own four (or more) properties with mortgages? Congratulations – you're a portfolio landlord, and your reward is…paperwork!
When totting up the number of mortgaged properties, those within a limited company owned by a landlord also count. So if you hold two mortgaged properties in your own name and two in a company, you're a portfolio landlord.
What do portfolio landlords need to provide?
The PRA has suggested to lenders that they look at documents such as:
- Property portfolio spreadsheet
- Cashflow forecast spreadsheet
- Income and expenditure spreadsheet
- Business plan
- Three months' bank statements
- SA302s and tax overviews from HMRC
- Tenancy agreements for all properties
It's still early, but it seems that most lenders will issue templates that allow you to present the data in the way they want it.
Looks like a lot to pull together? Well…yes, it is.
Each lender is allowed to decide exactly what information they want to make their decision. Some will want to see everything on the list, some might want more than is on the list, and others will start with some basic information and only ask for more if they think they need it.
Effectively, the idea is that they're not just looking at the new mortgage in isolation: they're assessing it in the context of your entire rental “business”:
- Got another property in negative equity? The portfolio spreadsheet will show them
- Buying in Newcastle when the rest of your portfolio is in London? Your business plan will tell them why
- Got empty properties and more expenses than income? The bank statements and tenancy agreements will flag this up
What does this mean?
It's a bit early to say for sure, but the effects of this are likely to be:
- More time-consuming applications, as you have to produce all this information
- Slower decision-making, as lenders have to look at it all
- More declines and re-applications, as any given lender could spot something in a portfolio that they don't like the look of – while another could be fine with it
None of this is good news for larger investors, but it's hard to get too upset about it. At the level of having four or more properties, you're unambiguously running a business – and any other business wanting a loan would need to submit all this kind of information.