It is unrealistic to believe that such a significant change as the reduction of buy-to-let tax relief will not have consequences
Under the Government’s proposed changes, higher-rate taxpayers could, for the first time, be liable for tax on their buy-to-let income even if they have not made a profit. It will be possible to experience negative cashflow just through the combined costs of mortgage interest and taxation: an impossibility under previous arrangements.
Removal of interest relief was always a possibility but very low on most landlords’ list of worries, with interest rate increases, poor-paying tenants and sudden repairs more pressing concerns. Most would not have even considered this risk when they bought their properties and will not, therefore, have modelled the change into their calculations (if indeed they got as far as modelling in the first place).
For those who bought at the wrong time or in the wrong place, or for those who are simply over-geared (which probably includes most who borrowed at the market norm of 75 per cent LTV), the changes are more than a nuisance: they pose an existential threat.
And it is not true that being a higher-rate taxpayer provides a cushion of wealth that makes it possible to ride out a sudden change to the viability of investments. While once it might have meant enjoying a significant level of income relative to the majority, this is no longer the case. For many of these borrowers, a sudden and unavoidable increase in tax of £100 or so a month will be the difference between profit and loss; between a bank account in the black or in the red; between being in mortgage arrears or not.
If borrowers are struggling to comprehend the impact on their finances that the changes will bring, it is not clear that lenders are yet any better placed.
The commentary already released (largely from buy-to-let lenders with a vested interest in talking up the market) seems to run along the following lines:
- Landlords will pass on the costs to their tenants – Yes, some will, particularly in London with its unbalanced supply and demand. However, in many areas of the country where tenant affordability is tight and supply is strong, that may not be a viable tactic.
- Landlords are savvy business folk who will adapt their strategy – But property is an illiquid asset and not easily adapted.
- Landlords will switch to borrowing through entities – Maybe, but that brings its own complexities that not every pensioner with a single property bought with their newly liberated pension is going to relish.
The changes will take time to bed down and show up any areas where a different stance is needed. However, it is clear that lenders will need to demonstrate responsible lending through a change to their underwriting processes and this will need to focus much more closely on affordability. Simply applying a rental coverage calculation and obtaining some bank statements and a budget planner seems underwhelming.
This is a mature part of the market and there is no reason to think it will not continue to be so. However, it is unrealistic to believe that such a significant change as the reduction of tax relief will not have consequences. After all, reduction now could easily progress to removal later.
The lending industry will have a key part to play in helping consumers adjust to a new norm. It will not do this by insisting all borrowers and would-be borrowers are business-savvy, experienced landlords with high levels of background income with which they can ride out the storm. They are not.
If buy-to-let is to continue to prosper, we need to tailor our overall approach to the more ordinary landlord, who has good intentions and some acumen but lacks the experience to deal with the complexities of operating in an increasingly difficult and regulated environment.
Jonathan Moore is head of credit at Dudley Building Society