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Today, I shall focus on another change for us property investors - the new lending requirements for portfolio landlords. Now, if you thought a portfolio landlord means people like Fergus Wilson with hundreds or even thousands of individual properties, think again. The magic number of rental properties that qualifies you as a ‘portfolio landlord’ and so, potentially affected by the new lending guidelines is a rather surprisingly low number at just 4 and no matter whether you own them individually, jointly or through a company.
I am guessing that the hurdle of 4 properties is going to impact quite a large number of you, so let’s get the low-down on these changes.
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If you have (or plan to have) 4 rental properties or more (in whatever ownership model), then you might want to prepare for a grilling on your next mortgage application! Best advice is to review the show notes and start pulling together the info outlined and if possible try and look at your application through the lender's eyes before you are ready to apply. You might need more time and to make some changes before you do!
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Transcription of the show
Hello and welcome to another episode of The Property Voice podcast. My name is Richard Brown and, as always, it’s a pleasure to have you join me on the show again today.
‘The only thing that is constant is change.’ So, said the Greek philosopher Heraclitus in around 500 B.C.
You will no doubt have to agree that his wise doctrine is very much alive and valid in today’s property market!
On top of the various tax changes that have been brought in and continue to be phased in over the next few years, there is a big change looming fast with landlord lending. In fact, there already is big change here right now with the new mortgage affordability rules at 145% rental coverage above mortgage payments and the notional 8% interest rate stress tests!
So, what more could we ask for than a bit more change then, you may well be asking?
Today, I shall focus on another change - the new lending requirements for portfolio landlords. Now, if you thought a portfolio landlord means people like Fergus Wilson with hundreds or even thousands of individual properties, think again. The magic number of rental properties that qualifies you as a ‘portfolio landlord’ and potentially affected by the new lending guidelines is a rather surprisingly low number at just 4 and no matter whether you own them personally or through a company.
I am guessing that the hurdle of 4 properties is going to impact quite a large number of you, so let’s get the low-down on these changes right now.
Property Chatter
If you have or intend to have 4 or more rental properties, regardless of type, so BTL, HMO, etc., and use mortgages or equivalent lending to help acquire them, then from 30th September 2017 some significant changes are coming in that will affect you.
The Prudential Regulation Authority or PRA is a part of the Bank of England, which regulates around 1,500 banks and building societies. This is most, if not virtually all of the BTL market. The PRA are the ones that brought in the 145% rental coverage affordability criteria and the higher interest rate stress test requirement at around 8% for most landlord investors using mortgage and similar lending.
Well, they are going a step further for a portfolio landlord that owns 4 or more rental properties from the end of September this year. First, let’s be clear about the definition of a portfolio landlord, which the PRA defines as:
“…borrowers with four or more distinct mortgaged buy-to-let properties, either together or separately, in aggregate.”
This definition also mops up properties held in joint names and held using a company, which is at least partially owned by the landlord. So, no sneaky way around the rules by having lots of special purposes companies or minority stake partnerships then! Yes, I had thought of that…
So, what are the changes?
Well, the from 30th September 2017, the PRA requires that all lenders carry out specialist affordability checks on any borrower who falls into this portfolio landlord category.
The checks are still a little subject to interpretation judging by some recent discussion that I have seen from some of the specialist BTL lenders, but will include the following as a minimum:
Your property investment experience
- The total your mortgage borrowing across all properties
- Verification of rent level across your entire portfolio
- Your property and personal assets and liabilities, including tax liability
- The merits of any new lending in context of your existing portfolio and your property business plan
- Historical and future expected cash flow from your portfolio
- Evidence of your income both from property and elsewhere
- Stress test and affordability checks as per other recently introduced changes
As a client of Shawbrook Bank for a number of years, many of these requirements were already in place for me and I was used to the inevitable ’20 questions’ that would follow a new lending application. However, the burners have been gradually turned up and the heat is getting hotter in the kitchen, even compared to what I have experienced to so far.
For some that perhaps fell into the PRA definition for portfolio landlords before these changes and maybe used a variety of the non-commercial lenders, or those about to come under the definition and scope of the guidelines for the first time, things may about to get a whole lot more complicated in terms of application requirements.
In practice, what do these requirements mean, how could they impact us and what could we do to be prepared for them?
Let’s work through the list now then to see…
- The total your mortgage borrowing across all properties
Shawbrook Bank usually asked me to provide a portfolio summary to accompany a new loan application and I have seen some of the templates that brokers are circulating that lenders will require under the new rules. Essentially, they are looking for the following minimum information in this portfolio summary for every property you own, not just what you are seeking lending for:
- Property address, original purchase price and purchase date
- Mortgage lender, account number & all mortgage holder names
- Current valuation, mortgage balance outstanding & monthly payments, along with details of the current interest rate and expiry date of any fixed period
- Current rental income and letting arrangements, such as agent or self-managed
- Historic maintenance costs and in some cases all other property cost and expenditure too, although they would assume a figure in any event
As a professional property investor, certainly one with 4 or more properties, we ought to be tracking this sort of information already, so that should not be a major challenge in terms of providing the info. It is more the assessment and verification of the info that is significant, which we will come back to later on. However, just to illustrate, I have been asked to provide copies of my mortgage statements and even had a request a one-off statement where the new lender felt that the last mortgage statement was too old for them to consider!
- Verification of rent level across your entire portfolio
I saw a mortgage lender panel discussion on this topic just 3 months before implementation and it was clear that there was still some differences in interpretation among lenders of the guideline issued by the PRA a year ago. So, do expect different requests in terms interpretation and of verification of all information provided and for with rent verification in particular.
Some lenders will want to see copies of all of your current ASTs. Others will undertake automated or even manual rent checks of their own. Some others may insist on a surveyor assessment of rent levels, although I suspect this is on the new application more than the existing properties, but you never know!
So, the best way to be prepared here is to make sure you have copies of your ASTs, which you may need to request from your letting agent. You might also want to do some level of average market assessment across the portfolio as a way of understanding how the lender might be looking at your portfolio behind the scenes. For example, if you are currently charging a premium rent for some reason, such as a pet premium or a furnished rental, then an average local area rent check might not support that level of rent…and so the lender might mark down the rent to the market average. I say might because, frankly, it’s not entirely clear what they will do!
Be prepared for different approaches from different brokers and lenders here I would say.
- Your assets and liabilities, including tax liability
Again, as pros we should be collecting this info anyway…I do, but I also admit, it is mostly updated around tax return time, so we might need to address this more frequently.
As for the tax liability, this could become quite complicated for some. Imagine, like me, that you own some properties personally, others jointly still others through various companies…all with different tax rates, reporting dates and requirements and the such. My accountant might have to get involved to assist here I think!
Of course, another consideration, as is the case with the ‘current valuation’ requirement in the portfolio summary: is who determined the value and when? If it was a recent, then perhaps that’s ok…but what if you have not had the property for some time?
- The merits of any new lending in context of your existing portfolio & your property business plan
This is an interesting one. Again, as a pro, we should be treating our property investment in a business-like manner, although we might not necessarily have a specifically written out business plan…especially if we only have 4 BTLs! As an aside, I can share a one-page template if you need one, just drop me a line.
The lender is mostly just looking to understand your investment strategy or strategies and how this new property fits into that, so it might be as straightforward as saying: ‘Long-term buy and hold strategy with an objective of retirement provision. This new purchase forms a part of that strategy by adding an income-generating asset to my portfolio.’ Obviously, it could also be a lot more complicated than that too!
In any event, most lenders prefer clarity, simplicity and especially certainty, so try and remember these points when sharing your business plans with them. If you have some complex variables that might mean you could change direction on one or all of your properties in the future, such as you will sell if the price is right, then it might just confuse the issue to include this provisions at this point.
Beyond the business plan, which is our personal perspective, the lender will also be forming their own independent perspective and we should not lose sight of that. So, try and take an objective look at our personal position subjectively, through the eyes of the lender. Ask yourself: does it makes sense, is it commercially viable, would I lend my own money to someone that looks like this?
Personally, I have a one-page Executive Summary of my property business plan, which is what I tend to share with the lenders. The full version I prefer to keep to myself.
Finally, I saw one or two commentators mention the new Energy Bill requirements planned for introduction from April 2018, which is just over 6 months away at the time of recording.
Properties with an EPC rating below E cannot be let out from April, unless under certain circumstances, making them less economically viable for landlords. Which beggars the question of lenders’ desire to lend on properties that potentially aren’t lettable or economically viable to let. This will affect all landlords, but in particular, portfolio landlords with a higher business risk to such regulation I suspect. More on this topic in a future episode perhaps, but you might want to make a note to check the EPC ratings in your properties in the meantime…
- Historical and future expected cash flow from your portfolio
This is another one that might be open to interpretation and different requirements from different lenders. For example, proving the cashflow. All lenders will ask for copies of bank statements, probably all personal and property bank accounts. Some will ask for 3 months (the minimum you should expect), others 6 months and yet others may ask for longer, especially if cashflow seems strained or inconsistent for some reason.
In addition, copies of Personal and Corporation Tax Returns from HMRC, along with the required formal confirmation, such as the SA302 for personal tax return confirmation will be needed to accompany the application and can take time to come through.
You may be asked for management accounts for the current year.
If your tax returns show a taxable loss, you may need to explain why. For example, if you undertake qualifying repairs and renewals this can give rise to an income tax loss. I have this situation, as one of my preferred strategies is buy-refurbish-refinance and so this brings in a lot of up-front, tax-deductible costs that won’t be covered by rental profits for some years to follow. This produces a tax loss, which rolls over year-on-year and so incentivises improving a property’s condition with tax breaks, but that does not always look good to a lender! Similarly, higher rate taxpayers might be projecting a cashflow deficit, especially if investing in low yield locations, such as London and using a mortgage.
Note, this is not the same as capital improvements, which can only be offset against capital gains and not income tax.
So, from either a cashflow or tax point of view, the portfolio might be viewed as cash negative, loss-making or both. This might need some explanation to these non-property investing underwriters. Therefore, prepare yourself for the Spanish Inquisition if your portfolio shows anything less than steady profits and cash positive performance I would suggest.
- Evidence of your income both from property and elsewhere
Lenders will need to understand what your property AND your non-property income looks like. It is the evidence part that will be at the very least annoying. We will be asked for payslips and P60s to prove PAYE income and our personal bank and property statements as mentioned previously, along with proof of any other income sources, such as pension, dividends and so on.
Then, it is a case of proving affordability in some cases, such as where we don’t meet the higher 145% affordability test on both new investments and on our total portfolio.
- Stress test and affordability checks as per other recently introduced changes
We should by now be aware of the higher bar we need to jump through as property investors. These are 145% of the mortgage payment covered by of rent and the notional interest rate stress test at something like 8% for people with less than 5-year fixed rate mortgages, even at rates of around 3% or 4% typically. These are significant changes that already limit lending on lower yield properties for higher-rate tax-payers.
However, it looks as though these tests will now be applied to the entire portfolio and not just the new property loan being applied for with portfolio landlords. Historically, we may have met a lower 125% rental coverage that most lenders had in place and we may also be perfectly comfortable paying 2% to 4% as a fixed-rate mortgage for the next couple of years before rent rises kick in as well. But, lenders will have to re-evaluate our portfolio based on the new guidelines of 145% mortgage payment rental coverage and the 8% interest rate stress tests. The result could mean ‘computer says no’ in some cases.
I therefore suggest that you undertake your own portfolio review using these criteria before committing to any new purchases to see how a lender is likely to assess you. Outside income may also be taken into consideration to top up any shortfall, however, this is going to be based around similar affordability checks as with lending applications for a home mortgage. The implication being that larger portfolios might require larger disposable income from non-property sources to sustain any perceived deficit in the portfolio based on the latest affordability and stress tests.
The point being, that these changes change the lending decision away from the facts as of now, into potentially unrealisable possibilities of the next 5 years instead. That’s quite a different level of assessment as I’m sure you would agree.
There is a ray of hope in case you might be thinking you could become a mortgage prisoner, stuck on an expensive standard variable rates due to failing to meet all of these higher guideline requirements.
It is expected, as with the residential mortgage market, that lenders will be required to assess a remortgage in a different way to new property purchase. This could mean a lower level of rental coverage required when all you want to do is switch to a new fixed-rate product at the end of the previous one.
So, there we go…if you weren’t aware of the new portfolio landlord lending guidelines before, you are now! These come fully into force from the end of September 2017, so you might just have enough time to get a new application rushed through and registered before then if you need to remortgage soon for example.
Failing that, I strongly suggest that you undertake a portfolio review of your own, adopting some of the new guidelines to evaluate how you would look to a lender when you next need to apply for a mortgage. You might then need to make some changes, such as selling properties, increasing rents and other steps to help improve how you will look on paper to the lenders in the new environment.
As said at the beginning…the only constant is change, so we must to be able to adapt to it as it comes our way.
Now, before I end today, just a quick work about The Property Voice Live Workshop on Saturday 7th October in London. I had to pre-record this episode in advance, so I hope by the time you hear this there are still some tickets left.
This is a workshop designed for new, early stage and turnaround property investors looking for practical insights & a step-by-step approach to their property investment plans & strategy from an experienced, trusted and non-guru advisor…maybe these tax and finance changes are making you have a bit of a rethink of your future plans, so it could be a good opportunity to take some time out and work on your plans with some guidance and peer-to-peer support too.
During the workshop, we will collectively work on your personal plans and strategy and some of you will have the opportunity to be coached live on the day, observed by the others. You will be able to network with me and your peers, both during the event, and in the relaxed Happy Hour afterwards.
Tickets are limited and are available from the Eventbrite listing in the show notes, or just drop me an email at podcast@thepropertyvoice.net and I will share the link. You can also email me if you want to talk about anything from today’s show or more generally in property investing. As usual, the show notes will be over at the website www.thepropertyvoice.net
But for now, all I want to say is thank you very much for listening once again this week and until next time on The Property Voice Podcast…it’s ciao ciao.