The Prudential Regulation Authority has sounded a warning to lenders regarding the way they currently assess buy-to-let customers.

The watchdog highlights recent tax changes that have made buy-to-let investment more expensive for higher-rate taxpayers. As a result these borrowers need higher rental incomes to break even. 

But it recent work in this area has found lenders are not fully accounting for this when assessing affordability.

These warnings come in the Bank of England’s ‘Bank Overground’ publication, designed to highlight internal analysis that support policy or operational decisions.

The analysis says: “The PRA expects lenders to take income tax into account when assessing affordability. If the mortgage interest tax relief changes [phased in between 2017 and 2020] were strictly enforced for affordability testing, higher-rate taxpayers would need to meet a higher stressed interest cover ratio of 167 per cent to be assessed to the same standard as an ICR of 125 per cent for basic-rate taxpayers.”

It points out that most lenders assess higher-rate taxpayers against a minimum stressed ICR of around 145 per cent, so compared to basic-rate taxpayers, lenders are accepting a lower net rental income for given mortgage repayments for higher-rate taxpayers. 

It says if all other factors are equal, this could make this lending riskier.

However the PRA adds: “The risk posed by such lending is low at present. The overall quality of buy-to-let lending has improved since 2016. And tax changes introduced since 2016, including the MITR, have meant the buy-to-let market has been very subdued.”

However it warns the industry that it will continue to monitor this risk in buy-to-let lending, raising the prospect of tighter lender controls being enforced in future.