Tougher buy-to-let underwriting regulations will lead to more lenders pushing five-year fixes to get around the rules despite the risk of a future backlash, according to experts.
The Prudential Regulation Authority consulted in March on stiffening buy-to-let underwriting requirements for all lenders not already subject to Financial Conduct Authority regulation.
Last week the PRA confirmed that lenders should test landlords’ affordability against a 5.5 per cent notional borrowing rate for the first five years of the loan unless the mortgage is fixed for five years or more. Loans where the remaining term is less than five years will also be exempt from this test.
The PRA said there would be no link between the 5.5 per cent notional interest rate and the Bank of England base rate.
The regulator also confirmed that future rent rises could be factored in to affordability checks.
The PRA wants lenders to start bringing in the new interest cover ratio changes by 1 January 2017, and to begin implementing the remaining changes by 30 September 2017.
The PRA announcement was received with grim resignation by the mortgage market, which did not expect the regulator to alter its original belief that more regulation was needed.
Speaking on the day of the announcement, Keystone Buy to Let Mortgages managing director David Whittaker said: “Today’s new underwriting standards from the PRA are in line with what we have been anticipating.
“We were resigned to it. Anyone who thought they could do a King Canute and roll back the waves was mistaken.”
Buy-to-let fixed rates tend to be short-term two- and three-year loans. But experts say the PRA rules could lead to buy-to-let lenders pushing five-year loans, as the new regulations do not apply to fixed-rate loans of five years or more.
Fleet Mortgages chief executive Bob Young says: “The PRA accepts that some lenders may use this as an opportunity to game the principles of the underwriting standards.
“Over the past few weeks we’ve seen a proliferation of five-year fixes. Partly that’s because the yield curve is as flat as I’ve ever seen it, so five-year money is cheap to buy. However, it is undoubtedly the case that some lenders are setting their stall out to do longer-term fixes to get around this issue.”
Young adds that five-year fixes can be the best option for customers, but that the PRA will take a dim view of lenders promoting these longer-term fixes for their own ends.
He says: “I think we will see a spike and the PRA will close that.”
But some brokers say many landlords will still prefer the shorter-term fixes as they wait to see how tax relief restrictions being introduced next year will affect them.
One 77 Mortgages managing director Alastair McKee says: “I get a lot of landlords that would like to put it to bed for five years. But even if five-year fixed rates do come back, I think a lot of landlords will still opt for two- or three-year rates, just because they want to see how these taxation changes that come in in 2017 will affect their business.”
A move towards five-year fixes could also lead to a backlash from consumers, Whittaker warns. He says five-year fixes taken out now will not end until 2021, when the landlord tax relief changes have been fully implemented.
If this income restriction leads to the landlord wanting to sell the property, there could be a conflict between landlord and lender.
He says: “They may have ignored all your warnings today but when they want to get out they will say ‘It’s unfair’. As we canter towards the five-year horizon, we have to be careful. It’s an easy solution to get the stress test to work but for someone who is buying in their own name they’ve got to fully understand that they will get a large tax bill in 2021, inside the five years. If they think they have to offload the property and then find they have an ERC, they will not remember the reasons they took that five-year fixed rate.”
Others say that the PRA’s changes will nudge the market away from mainstream lending towards more specialist channels.
Paragon Mortgages managing director John Heron says: “We would expect these measures to restrict the level of growth in the buy-to-let market by cutting out more marginal business. We also expect a larger proportion of the market to be specialist in nature, consisting of more professional portfolio landlord business.”