Mind the trap

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We’ve mentioned earlier that interest rates for residential mortgages have fallen. However there have been notional increases in rates for buy-to-let mortgages. Some individuals are becoming trapped with their buy-to-let mortgage due to changes in legislation.

For those of you who have a buy-to-let (BTL) mortgage, just be aware that if you want to remortgage the landscape has changed.

Last year the Prudential Regulatory Authority (PRA) announced new underwriting standards for BTL mortgage lenders. This was based on growing concerns that large increases in the BTL market place could represent a threat to financial stability if BTL lenders failed to apply appropriate lending standards. Currently lenders want to see that your property will generate an adequate level of rental income to cover the mortgage interest by a certain margin.

Typically lenders require the rental income to cover the mortgage interest by a margin of 125% calculated at a “stress” interest rate of 5% and not your actual mortgage rate. These new guidelines require lenders to take two important aspects into account:

1) Affordability
Lenders need to ensure their policy takes into account the additional costs associated with your property such as management fees, maintenance costs and rental voids. They will also factor in the increases for higher rate tax payers from 6th April 2017 as the tax relief on mortgage interest will gradually reduce.

2) Stress Test
Unless the interest rate is fixed for five years or more, lenders need to forecast for potential interest rate rises, essentially taking the higher of:

· Market expectations of future interest rates;
· An increase of at least 2% above today’s levels (currently 2.25%);
· An absolute minimum interest rate of 5.50%.

What does this mean for BTL landlords like you?

The rental income you currently receive may no longer support your current mortgage. For example, a monthly rental income of £750 would support a £144,000 mortgage based on an interest rate of 5% and a rental coverage of 125%. An increase to the stress rate to 5.5% at 125% coverage would reduce the mortgage to £130,909. An increase in the rental coverage to 145% at a stress rate of 5.5% would reduce the mortgage event further to £112,850.

We know of lenders that require a rental coverage of 155%. Do you know what rental coverage and stress test your current lender would apply? Some lenders will take into consideration your personal income to supplement your borrowing. This would be based on a detailed affordability assessment to ensure that there is spare disposable income after fixed and regular commitments are accounted for.

This is in addition to the changes in the tax relief rules for borrowing and the withdrawal of the “wear and tear” allowance which allowed 10% of the profit to be deducted before tax, for fully furnished properties. It would be prudent to see what impact these changes will have on your financial planning.

Don’t leave it too late to plan!

Information is based on our current understanding of taxation, legislation and regulations.
Any levels and bases of relief from taxation are subject to change.
SKF Trading Ltd, trading as SK Financial

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