If granted, the powers will allow the Financial Policy Committee to ask lenders to stress test how much new landlords can borrow and ensure that the income landlords receive is greater than the interest payments on their mortgages.
Lending on investment property is typically secured against the rental income a landlord can generate. For most lenders, landlords are assessed on whether the rent generated from the investment property will cover 125% of the interest component of the mortgage. This gives both the lender a degree of security against interest rate rises and takes into account the money a landlord will reinvest back into the property for general maintenance and improvements.
At present, the interest rate against which the borrower’s ability to meet repayments is at the discretion of the lender. Over the past two years, this rate has typically been around 5%, translating into 1.2% above the 3.8% rate at which the average landlord secures their loan. For the average landlord who has purchased during 2014, the rental income from the property covered 205% of the mortgage interest, well inside the 125% limit. Tested against an interest rate of 5%, generally the rate which lenders currently use to test affordability means the rent will cover 165% of the mortgage interest.
The implementation of the findings from the Mortgage Market Review has seen the ability of new owner occupiers to meet higher repayments tested at interest rates of up to 7%. While powers have yet to be formally granted, the implementation of stress testing alongside a potential rise in interest rates, would see new landlords have to put in larger amounts of equity to obtain mortgage finance. Stress tested against an interest rate of 7%, in similar fashion to owner occupiers under MMR, a third of new mortgaged investors would have to increase the amount of equity they put down, amounting to an additional £40,000 on average.
Commenting on the Bank of England’s proposals, Nick Dunning, Group Commercial Director, Countrywide plc, said:
“Stress testing of new loans for investors has the potential to increase the entry barriers for would-be landlords. It will primarily affect areas in the South of the country and areas where yields are lower. If the proposals are implemented, would-be landlords will have to put down increasingly larger deposits to meet more stringent lending criteria. The high value nature of parts of London and the South East mean many landlords will find themselves having to put down deposits upwards of 40%. While lenders need to ensure repayments are affordable to the borrower, they must ensure they strike a balance between affordability and viability.”
