The Buy-to-Let landscape has shifted dramatically in a short space of time, from a booming housing market, low interest rates, to an environment of uncertainty around where bank base rate will end up, higher interest rates across lending products and challenges as to whether the cost of property will increase or decrease. Despite the UK government and Bank of England trying now to provide a level of stability into the market, it is difficult to not think the damage has been done as we look at the new Buy-to-Let scene.
As investors start to look to secure their next Buy-to-Let investment they are now faced with a new set of challenges many may not have come across. Not only are they facing some of the highest interest rates in over 15 years, but any existing BTL mortgages are likely to increase once their current rate comes to an end, and with an ever-increasing emphasis on stress rates and Interest Cover Ratio (ICR) from lenders, landlords are faced with some real challenges to meet the current market conditions.
As affordability of loans starts to become more complex, we must remember a Buy-to-Let mortgage must be covered by more than just the monthly rental income. In an ideal and well thought out plan, the rental income will cover the mortgage, interest, property cost (e.g., insurance, maintenance etc.) and leave you with a profit. But when lenders consider product ranges, they typically build-in a safety net to ensure the rent is more than sufficient to cover the mortgage payment (so the loan can be paid back), but also act with a duty of care to the borrower, ensuring the mortgage offered is affordable in current market condition. These stringent parameters are put in place to make certain borrowers and the loans provided meet the lender’s affordability tests.
One such measurement of affordability is looking at ICR. This is worked out by the annual rental income being compared to the mortgage interest rate and monthly payment, to give you a number to ensure the rental income will cover the interest of the loan. A fictional example, a £50,000 loan at 5.55% on a property producing £7140 annually would result in an ICR over 2.50 and the loan application would be sufficient.
The rental income would cover the loan amount, and meet ICRs, but Stress rates would also need to be accounted for to complete a successful loan application. Stress rates provide a lender with an even greater deal of security in knowing the loan can be repaid. A stress rate set at 9% would require the initial £50,000 being compared to monthly payments at 9% (and not at the 5.55% interest rate), which is almost double the interest rate offered by the fictional lender previously mentioned. In addition, lenders will take a view on the current tax status of the client and how the rental income would be treated by the HMRC at year end. This can mean that the rental will need to cover 125% of the stressed mortgage interest for basic rate and limited company borrowers, up to 145% + for higher and additional rate taxpayers. Meeting such numbers is proving difficult for investors as other criteria need to be considered, including the deposit and LTV resulting in many deals not meeting the ICR due to current higher stress rates, meaning potential investors are not able to purchase or existing landlords’ remortgage existing assets.
The increased change to meet ICR and stress rates is the biggest challenge for the Buy-to-Let market in 2023. Rental income becomes a fine balance of market value vs tenant affordability, and landlords should consider the rental yield which they can achieve. With the Southeast and London averaging between 2.5-3.5% yields, the math’s just doesn’t add up for many investors.
One-way ICR challenges can be met is by limited-edition products which offer rates at beneficial pricing. The product ranges will be on the market in the short-term to ease the pressures of rates, allowing landlords to continue working with specialist lenders like West One, who take a manual approach to applications. The automated approach high street lenders use such as calculators and affordability models can sometimes limit investors' opportunities for having their cases assessed. This is usually the result of the set criteria offering little to no flexibility for unique cases. With a specialist lender the asset of a strong service team to work on cases on an individual basis proves invaluable, as they can work directly with investors and brokers to help alleviate ICR challenges.
Many products will now come with little or no early repayment charges (ERC) as part of the product offering. This stimulates the market, and becomes more attractive to borrowers, during an uncertain time, with little to no risk for the lender. If rates dropped dramatically, borrowers could change product, providing brokers with opportunities to secure further business as they move landlords onto new products.
We may start to see top-slicing, taking the clients disposable income into account to fund any ICR shortfall, become a more common part of underwriting criteria across the BTL lending space. Lenders will look to innovate their approach to accommodate the new world we find ourselves in and specialist lenders are often better placed to address this.
Working with brokers, and specialist lenders like West One can help provide different ways to approach current ICR challenges which many landlords are facing. Being able to work with brokers can help property investors assess affordability, not just relating to whether you have enough money in the bank or have enough rent to cover mortgage payments but affordability needs to consider a contingency plan to satisfy the lender. Such satisfaction may not be attainable in the current market, prompting borrowers to lower their LTV ambitions or seek a more tailored approach which specialist lenders can provide.
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