There&#39s no recklessness in buy-to-let

As the buy-to-let debate continues to fill column inches in the financial press, some criticism has been directed at lenders for jumping on the bandwagon and lending too much to buy-to-let investors, as fears grow that they will be the first to fall prey to a downturn in the market.

Michael Coogan, director-general of the Council of Mortgage Lenders, has leaped to the defence of responsible mortgage lenders in a letter to the Financial Times (June 5 2002). At the same time, he welcomed and endorsed the FT&#39s timely reminder of the importance of careful research and planning before embarking on this type of investment.

There are now at least 70 lenders vying for a share of the buy-to-let market and offering borrowers a greater degree of flexibility than ever before. The by-product of this can only be good news for buy-to-let investors, because it means more choice, more control and less expensive mortgage funding. According to Coogan, figures from the Council of Mortgage Lenders, based on at least 80% of buy-to-let lending, show that lenders are maintaining prudent underwriting criteria despite intense competition.

Most lenders use a two-pronged approach when it comes to assessing the size of a buy-to-let loan. First, there is the 130% proviso, which insists that the rental income is at least 125-130% of the monthly mortgage payment. This ensures that rental income is sufficient to cover the mortgage payments, expenses such as agents&#39 fees or maintenance, and periods when a property is unlet and not bringing in an income. The figure of 125-130% has remained at the same level since buy-to-let lending started to become more mainstream back in the late 1990s, so it would be wrong to suggest that the rules are being relaxed to become more accommodating.

Secondly, most lenders insist that investors have a deposit of at least 15%. According to figures released by the Mortgage Business, over half of its buy-to-let completions last year involved deposits of at least 25%, indicating that many landlords are not entering into their investments lightly.

Further figures from the CML show that arrears in the buy-to-let sector continue to be significantly lower than for the residential mortgage market as a whole, currently standing at half the level of the domestic mortgage market.

In addition to building in safeguards to ensure that borrowers don&#39t overstretch themselves, many lenders are offering features that provide sufficient flexibility to enable landlords to protect themselves and their investment. Mortgage Express, for example, offers a flexible payment feature, Choices, that allows borrowers to adapt their mortgage payments to suit their income and expenditure. When they can afford to they can arrange to overpay their mortgage, and thus build up a fund that could come in extremely useful if a property becomes empty for a while. The extra payments can be used to fund a period of reduced payments, or even a complete payment holiday altogether. On the other hand, surplus payments can be used to pay for maintenance or repairs, or to fund a deposit for another property. Landlords who don&#39t need to draw on the overpayments can simply use them as a tax efficient way of saving, lowering the amount of interest due, or even shortening the term of the mortgage.

Fixed rate mortgages are proving to be a very popular option for buy-to-let borrowers, because of the budgeting and planning advantages they bring – not to mention the value – and there is no shortage of competitive deals on offer.

According to Coogan, as much as 40% of buy-to-let lending is actually remortgage activity. This indicates that the scale of buy-to-let growth is not only less drastic than some figures would suggest at first glance, but also that buy-to-let investors are, on the whole, a financially astute bunch who are prepared to shop around and take advantage of the competitive financing arrangements on offer.

One of the few things that industry commentators do agree on are the factors that lie behind the phenomenal growth of the buy-to-let market, namely soaring property prices, interest rate lows and falling stockmarkets. Where the pundits differ, however, is over where the market goes from here. Without the benefit of a crystal ball it is almost impossible to predict, but if the housing market remains steady and prospective buyers do their homework, buying-to-let can still be a profitable investment – and a viable alternative to the stockmarket – over the medium to long term.

According to government figures quoted by Capital Home Loans, a specialist in the buy-to-let sector, a 1.6 million increase in the number of households is predicted by 2010, which will coincide with an anticipated shortfall of 520,000 properties (National Housebuilders&#39 Federation). In other words, the bedrock of buy-to-let success – demand for accommodation to rent – is not going to disappear. The secret is to choose a property with care and make sure that is in an area where there is a lot of potential rental demand. Easy access to transport is crucial, as is a good local employment situation and a pool of prospective tenants. Where there is lots of competition it is the quality of the accommodation that will win the day and it also seems that better quality accommodation tends to attract better quality tenants.

Most people would agree that we are unlikely to see the same levels of growth in buy-to-let as we have witnessed over the last few years, but the popularity of the market still remains strong. While there is sufficient demand from potential tenants, continuing house-price inflation and meagre rewards to be had from equities, investors will continue to invest in property to let. If they do their homework and are protected by safeguards imposed by responsible lenders, there is no reason why buying to let shouldn&#39t reward their endeavours over the medium to long term.