On 29 September 2016, the Prudential Regulation Authority (PRA) released Supervisory Statement 13/16 on underwriting standards for buy-to-let mortgage contracts (BTLMC), setting out the PRA's expectations when underwriting a BTLMC.
A list of minimum standards which the PRA expects firms to apply when underwriting relevant buy-to-let mortgage contracts The standards apply whether the borrower under a BTLMC is an individual or a company.
Before approving a buy-to-let application, all PRA regulated firms must undertake an affordability assessment. This includes an interest coverage ratio (ICR) test and/or an income affordability test.
The ICR test will assess whether the monthly rent is enough to cover the monthly interest payments. It should also take into account future interest rate rises. When assessing a borrower’s minimum ICR threshold, firms can use a variety of information, including data based on models. The PRA also provides a list of borrower costs which should be taken into account. This includes management fees, ground rent, insurance and utilities.
If a borrower is using their personal income to supplement rent income, firms will have to conduct a detailed income affordability assessment. This should take into account certain criteria, including the borrower's income, savings, investments, credit commitments and living costs.
When assessing affordability, firms cannot rely on equity in the property provided as security or any predicted increase in property prices. They will also have to assume a minimum borrower interest rate of 5.5% for the first five years of the BTLMC.
Portfolio landlords (defined as those with four or more mortgaged buy-to-let properties) will be subject to more specialist affordability assessments. Firms will be expected to ask additional information from the borrower. This includes evidence of their experience in the buy-to-let market, information on their assets and liabilities, the merits of the proposed new lending within the context of the wider portfolio, and past and predicted cash flows.
However, there are certain exclusions. The rules will not apply to consumer buy-to-let lending, or 'corporate lending' (which is defined as lending by firms’ corporate or commercial banking divisions using their specialist underwriting processes, including corporate real estate of development finance). Also excluded are existing borrowers asking for consent to let, or to BTLMCs with a term of 12 months or less. Those who are remortgaging without taking out additional borrowing will also fall outside the new rules.
The PRA also makes it clear that firms cannot use the SME supporting factor when conducting buy-to-let business, which reduces capital requirements on loans to small and medium sized enterprises by around 25%.
The PRA has agreed on a phased implementation. Firms will be required to implement the changes to ICR tests and interest rate stress tests by 1 January 2017. The other requirements need to be in place by 30 September 2017.
If you would like to discuss how these changes might affect your business, please contact either Russell Kelsall, Partner (russell.kelsall@TLTsolicitors.com or 0333 006 0695) or Emily Morton, Solicitor (firstname.lastname@example.org or 0333 006 1525) in TLT's Financial Services Regulation team.
This publication is intended for general guidance and represents our understanding of the relevant law and practice as at September 2016. Specific advice should be sought for specific cases. For more information see our terms and conditions.