As seen in the January edition of Master Investor Magazine.
By Carl Shave of Just Mortgage Brokers
Buy-to-let landlords are set to endure a tougher time obtaining a mortgage in the coming months. Following repeated warnings from the Bank of England’s financial policy committee, the Treasury is preparing to hand greater powers to the Bank of England in order to enable the latter to regulate the buy-to-let market more effectively.
The Chancellor, George Osborne, made the decision in an effort to prevent landlords from increasing average house prices and threatening financial stability.
The buy-to-let sector grew dramatically last year, with lending rising by 10% in the first nine months alone. This is part of a wider growth within the market, which has seen landlords make an estimated £180bn in capital gains over the past five years.
A number of lenders, including Barclays, have tightened lending criteria, with the industry norm of requiring rental income to exceed 125% of interest payments (calculated at a mortgage rate of between 5% to 6%) increased to 135% for all new applicants.
With such important changes being introduced, it seems increasingly likely the buy-to-let market, which has been growing so dramatically, is set to level off.
This is compounded by the fact that tax relief for wealthier buy-to-let landlords will be gradually cut to a flat rate of 20% from 2017 (compared with the 40% or 45% that landlords currently enjoy). As expected, the change has been fiercely contested, and is far from popular with those affected. Some landlords, unwilling to adjust their strategy, are threatening to leave the private rented sector entirely.
Changing Trends in the Buy-to-Let Market
Much has changed in the buy-to-let market since the credit crunch, and with sustained government scrutiny this looks set to continue. Many specialist buy-to-let mortgage providers have fallen by the wayside following the financial crisis, having chosen to no longer accept new business. However, with the big growth in the sector, some have returned and other new challenger banks have also entered the fray.
Lenders looking to grow their buy-to-let mortgage books are seeing much greater competition in mortgage deals. And with the steady decrease in mortgage rates over the last 12-24 months, investors have benefited from some very attractive loans, and in turn, very good rental yields.
Although certain lenders have adjusted how they calculate the maximum loan amounts permitted, low borrowing rates for the foreseeable future mean landlords will continue to see value from buy-to-lets.
Other Challenges to the Buy-to-Let Market
The buy-to-let market has enjoyed a golden spell recently, with interest rates at an all-time low and landlords reaping the benefits – part of the reason for the changes being introduced by the Chancellor. However, new challenges are on the horizon, besides the measures that will come into effect with the Bank of England’s new powers.
Perhaps the most significant is the additional stamp duty charged on rental properties and second home purchases, which will take effect from April 2016.
The Chancellor announced in his Autumn Statement that an additional 3% in stamp duty will be payable on buy-to-let properties across all bands. For example, a property worth £275,000 will be subject to stamp duty of 8% rather than 5%. So the calculation for a landlord would be £125,000 at 3% plus £125,000 at 5% plus £25,000 at 8%, which equals £12,000, rather than the current £3,750 – an increase of more than 200%.
David Cox, Managing Director of ARLA (The Association of Residential Letting Agents), has been damning in his evaluation of the stamp duty changes. “When the rabbit was first pulled out of the hat, we said these changes would be ‘catastrophic’ for the rental sector, and this has been echoed by letting agents across the country,” notes Cox. “The new stamp duty increases will make owning Buy-to-Let unprofitable for a lot of landlords, and certainly make new investors think twice about purchasing a Buy-to-Let property.”
Much of the discussion surrounding the future of buy-to-let centres on the intent of property investors. As a long-term capital growth tool, the buy-to-let market is still relevant and makes sense as an investment. However, it’s a different proposition for those looking for a short-term source of income. Those relying on income generated by their properties should approach the market with caution.
Buy-to-let is an unpredictable source of income, and with the challenges the market now faces, it’s likely the marketplace will become more unpredictable, at least in the short term. But what are the long- and short-term effects of the buy-to-let shakeup likely to be?
Effects in the Long and Short Term
The new criteria being introduced by lenders will no doubt have far-reaching consequences for landlords and the effects will certainly be felt. In the short term, larger deposits are likely to be required, which will see the market stumble while it adjusts. Having said that, although very low interest rates continue to give little encouragement for people to save money, value will probably still be found in investing in property.
In the longer term, the effects of such changes will perhaps be felt more by tenants of buy-to-let properties. Rents are likely to increase across the board, in order to compensate landlords for the extra costs from the new tax relief laws and new lending criteria. Does this long-term analysis answer the question as to whether buy-to-let properties are worthwhile?
It’s hard to judge. While value in the buy-to-let market for landlords is unlikely to be dramatically damaged in the short-term, the effect on tenants may be significantly more damaging. Landlords are, after all, dependent upon tenants to help the market thrive, but with costs rising, tenants may be tempted towards buying instead of renting.
The knock-on effect of such a movement could see the mortgage market grow while the buy-to-let market suffers. Equally, the buy-to-let market may continue to thrive, as it has in recent years, but this depends on how much rental rates rise.
With stamp duty also set to be an important contributing factor to the future of the buy-to-let market, everyone within the mortgage and property sector will be waiting to see how the recent changes will affect both landlords and tenants. With costs rising in the short term, the buy-to-let market seems set for a dramatic shakeup.
About the author
Carl is a seasoned commentator on financial matters and one of the minds behind Just Mortgage Brokers (www.justmortgagebrokers.co.uk). He has worked in the Mortgage Industry for over 20 years, first working for a high street lender and then departing to setup and run his own branch of mortgage brokers 15 years ago.