Dropping rental cover is a gamble

When specialist lenders create products to cater to hitherto unrecognised niche markets they are increasing their volumes through innovative business practice. And when interest rates rise and volumes dip, lenders are tempted to loosen their criteria to sustain volume.

So into which category should we put the news that one lender has dropped its prime buy-to-let rental coverage to 75%?

Many landlords have substantial portfolios. Rental assessments based on property characteristics may not be accurate measures of risk. Some landlords have budgeted in an element of salary to meet their mortgage payments, particularly as the base rate has increased and rents no longer cover mortgage payments.

A product that takes all the above into acc-ount and combines underwriting the credit of clients – as with residential mortgages – with underwriting rental security is surely an example of innovative specialist lending.

To justify this product, I have assumed that the underwriting process changes from the standard buy-to-let process to include an assessment of borrower income. But in reality I suspect this drop to 75% cover has not been matched by increased checks on borrower affordability and is based instead on a traditional rental coverage calculation.

If this is so, this lender has decided that rental cover of 75% is an acceptable credit risk. This is dangerous because no checks are made to ascertain where the other 25% comes from.

At this stage, the question of rental coverage becomes irrelevant. What’s the difference between rental coverage of 75% and 50% – or 10%? The lender is making a guess regarding affordability. Buy-to-let is unregulated but it would be interesting to see how it shows that account is being taken of customers’ ability to repay loans, as the Financial Services Authority requires.

Given the 1% rise in the base rate since August 2005, landlords are facing lower yields. Rents haven’t increased that quickly so the buy-to-let equation no longer stacks up. New business in buy-to-let should be down as borrowers need substantial deposits to get monthly payments down to levels where conventional rental coverage calculations are possible.

By dropping rental coverage to 75%, lenders are making it easier to get buy-to-let deals at a time when rational property investors should be holding back. House price growth is slowing and the number of landlords marketing their properties is rising. Undoubtedly, this is largely down to profit-taking but it could also be a sign that landlords are finding it hard to cover their mortgages and are rationalising their portfolios. Decreasing rental cover does not seem to be an example of innovation – more a gamble to increase volume.