Affordability tests may result in risky B2L lending, says Paragon

17 January 2011 | By Natalie Thomas

John Heron, managing director of Paragon Mortgages, says some lenders’ affordability tests risk a return to unsuitable and irrespon-sible lending practices in the buy-to-let market.

Writing in Mortgage Strategy this week, Heron says with an interest rate rise on the horizon, lenders in the buy-to-let market need to stress test affordability based on a separate assumed rate, not product rates.

He says the market standard Interest Coverage Ratio requires that the rent exceeds the interest charge by 25%, with an assumed rate of interest at 5%.

If interest rates hit 5%, rates on most current buy-to-let mortgages will be 8% or 9%, suggesting that lenders using a market average ICR of 125% at 5% are not adequately stress testing affordability.

Heron says once interest rates start to creep up, it will make some lenders’ mortgages unaffordable for many.

He adds: “We thought that we had seen the back of naïve and irresponsible lending in buy-to-let but could it be that some lenders that were not impacted by the 2007 crisis are already engaging in unsustainable lending practices that will harm themselves and their customers?”

Lloyds Banking Group says it offers buy-to-let products on a rental calculation at 125% of the product pay rate.

But a spokeswoman says: “As a responsible lender, we calculate buy-to-let affordability on the basis that the rental income must cover 125% of the monthly payment.

“This approach demonstrates that landlords would be well placed to handle any future changes in interest rate.”

David Whittaker, managing director of Mortgages for Business, says some types of affordability assessments might not be a problem for longer term deals over five years, but could pose problems for short-term ones.

He says: “Although rents are likely to go up in the next few years, they will not go up enough to cover a large rise in interest rates for some landlords.”

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