Rising mortgage interest rates have taken their toll and the buy-to-let (BTL) sector is no exception.
This market has many specialist lenders offering a range of products with complex criteria. However, these lenders have struggled the most with pricing due to the volatility of the swap markets.
This volatility has given BTL advisers a lot to manage, with rates withdrawn at short notice, rapid rises affecting affordability, increased workloads (having to research the market multiple times for each case), and slower service from lenders involved with their own challenges.
It’s good to see some innovation to help affordability
The speed at which rates are pulled means advisers must submit applications quickly, which can result in mistakes. Some lenders are unable to offer flexibility over errors and request the re-submission of the application, resulting in the rate being lost.
Settled down
At the time of writing, the market appears to have settled. We have seen rate reductions as lenders get to grips with new pricing models, and more swap rate stability. But the affordability challenge will remain, I fear.
Since the Prudential Regulation Authority’s (PRA) introduction of the BTL affordability rules in 2016, five-year fixes have been very popular. The PRA requires affordability to be based on rates rising to 5.5%. However, the rules allow for fixed rates of five years or more to be excluded from the projected 5.5% requirement.
Clients could consider the limited company route to secure the 125% margin if it is a new purchase
With rising interest rates, the new five-year fixes now mostly exceed the 5.5% notional figure. In the residential market, discount rates have become popular because they are much cheaper at the start. However, in the BTL market this increases the affordability issue because most lenders now use a much higher notional rate than the PRA figure — some as much as 8.5%.
The higher notional rate affects new purchasers by lowering the loan-to-value they can achieve. We have also seen it affect investors who purchased a few months ago with a bridge and are now struggling to raise enough to repay the outstanding loan.
Mortgage prisoners
Not long ago, property investors secured five-year fixes below 4% with the rental affordability calculated on that sub-4% rate. Those properties will come up for remortgage in the coming months and years, and there’s a significant chance of a rise in BTL mortgage prisoners.
Many lenders now offer top-slicing, where either surplus rent or surplus earned income is used towards affordability
It is good to see more lenders offer retention rates, including some specialists. This may help investors control the rate rise they would otherwise have to suffer.
We often see professional property investors using a rate review date as an opportunity to raise capital to enable investment in other properties. Should the government’s bill requiring landlords to bring all properties to an energy performance certificate rating of C or above continue as planned, raising capital for property renovations may be even more in demand.
It is worth advisers investing time in understanding potential solutions. These can be simply exploiting the criteria differences between lenders, or keeping abreast of new, innovative products.
The higher notional rate affects new purchasers by lowering the loan-to-value they can achieve
If a client reaches the end of their rate and their lender does not offer a suitable retention rate, remember the PRA like-for-like rules. These allow lenders to choose the rate used to assess a like-for-like remortgage, so there is a variance between lenders and their calculation rate.
For example, Coventry uses a reference rate of 6.5%, and TMW, for limited companies, uses a five-year pay rate plus 0.5% with rates from 5.49%. Quantum has waived its interest coverage ratio requirement completely for like-for-like remortgages with a 24-month payment history.
It’s good to see some innovation to help affordability. Precise has launched a limited-edition five-year fix at 5.44%. By applying a more significant fee (4%), it can set a lower rate to use for affordability.
Lender margins
Another area to look at is the margins used by lenders in their calculations. Most lenders use 125% for limited companies and basic-rate taxpayers. For higher-rate taxpayers buying in their own name, the rate often used is 145% but, as lenders do not have to follow a specific PRA rule for this part of the calculation, it can vary. Harpenden uses 135%, and Clydesdale and Mercantile use 125%.
It is good to see more lenders offer retention rates, including some specialists
Clients could consider the limited company route to secure the 125% margin if it is a new purchase.
Many lenders now offer top-slicing, where either surplus rent or surplus earned income is used towards affordability. With lenders such as Aldermore, this reduces the margin to 110%, and Virgin allows income to be used to cover shortfalls above 100% for non-portfolio landlords.
The BTL affordability challenge will remain as we settle into the new rate environment. But the appetite to lend is still strong.
Liz Syms is chief executive of Connect Mortgages
