The Prudential Regulation Authority’s consultation on underwriting standards is fraught with risks
Policymaker intervention in the buy-to-let market took on a new dimension last week with the publication of the Prudential Regulation Authority’s consultation on underwriting standards.
Essentially, the PRA wants to introduce a minimum set of underwriting standards for buy-to-let lenders to ensure they lend in a “prudent manner”. It wants lenders to take into consideration future interest rate rises for a minimum period of five years from the loan’s start date.
The PRA proposes that lenders stress test by taking into account market expectations, a minimum increase of 2 percentage points in buy-to-let interest rates and any prevailing recommendation from the Financial Policy Committee regarding appropriate stress tests. Further, it wants lenders to assume a minimum borrower interest rate of 5.5 per cent during the first five years.
The PRA also proposes that all firms use an affordability test when
assessing a buy-to-let contract in the form of an interest coverage ratio test and/or an income affordability test. This element should hold few worries for lenders because many already employ these methods.
The final strand of the consultation concerns portfolio landlords, which the regulator is intent on labeling as those with four or more properties. In addition to this, it is seeking to ensure lenders use specialist underwriting processes that account for the complex nature of these transactions.
While one cannot argue with the intention behind the PRA’s actions, there are undoubtedly risks when introducing minimum requirements for any market.
First, those minimum standards must not be set so high that they choke the market and deter landlords from investing because, ultimately, tenants will pay the biggest price in this scenario.
Then there is the effect on competition and choice. Competition in the buy-to-let sector is very strong at present, with a healthy range of options on offer to borrowers. However, introducing a uniform approach risks holding back innovation – ironic at a time when the FCA is investigating barriers to competition in the mortgage market.
This consultation is not the buy-to-let sector’s equivalent of the Mortgage Market Review, but it hints that the political will is there and it is surely now one step closer.