Through the rocky waters of Affordability in Buy-to-Let

The turbulent past twelve months has seen the landscape change with the UK economy and property market facing challenges it hasn’t seen for many years. As the sand shifts, they've exposed rocky terrain around inflation, cost of living and raising interest rates which the UK must navigate.

Arguably inflation is currently the largest factor driving interest rates higher, as BoE use rate rises to drive down inflation. Inflation rises have been a result of a turbulent UK economy exacerbated by the Ukraine-Russia conflict which has impacted energy, prices and food prices. As the UK reach the end of peak heating season, we can expect further downward pressure on energy prices, and an opportunity to grow reserves.

Additionally, for anyone who does a regular weekly shop, they can agree on the noticeable increase in food and drink prices in recent times, reflected by a 19.25% increase from March 2022, with these driving costs and headlines around the cost-of-living crisis.

Latest data shows the UK economy grew by 0.1% in Q1 2023 from the previous quarter, and inflation eased to 10.1% in April. This is still above the target levels, and current levels will continually put pressure on consumer spending and outpace ‘real pay’. The marginal changes illustrate we are not out of troubled water just yet, but calmer waters are on the horizon. Reflected by Chancellor Jeremy Hunt’s comment, "It's good news that the economy is growing but to reach the government's growth priority we need to stay focused on competitive taxes, labour supply and productivity."

Rocky storm before recovery

The largest outgoing for many households are mortgage payments, whether for residence or Buy-to-Let investment. How can we overcome these to ensure the property market doesn’t stagnate?

As investors look to their next Buy-to-Let investment they must consider their current rate increasing but also, an increasing emphasis on stress rates and Interest Cover Ratio (ICR) from lenders.

As affordability becomes more complex, we must remember a Buy-to-Let mortgage must be covered by more than just the monthly rental income. 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 conditions. These parameters are put in place to ensure borrowers 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. As stress rates start to have more emphasis placed on them from lenders it’s important to look at how these can be alleviated so that opportunities are captured by investors.

Fair winds and following seas

Despite the challenges, there are lenders and products which are showing the path to safe shores.

Many expect in the short term, interest rates may reach 5% by BoE, but in medium term, these will start to reduce to help property buyers meet affordability. Buyers cannot wait for these times, but what is required is flexibility to understand challenges of today, without the fear of locking into a longer-term rate which may be higher than in three years’ time.

ICR challenges can be met by limited-edition products offering products at beneficial pricing, offered in the short-term to ease the pressures of rates, allowing landlords to continue working with specialist lenders like West One.

Innovation will drive the market. Buy-to-Let products from West One which provide a five-year fixed rate, with the flexibility to search a new product after, if beneficial rates become available without the penalty of an early redemption charge after year three, thus stimulating the market during an uncertain time. If rates dropped, borrowers could change product and provide brokers with opportunities to secure further business.

Working with brokers, and specialist lenders like West One provide different approaches to ICR challenges which landlords face. Brokers can help property investors assess affordability, not just relating to whether you have 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.

With flexibility in the market all important, let’s not abandon ship just yet, but maybe keep a tighter grip on the helm in case we need to change course.