The mortgage credit directive: tips for landlords
Find out about the Mortgage Credit Directive, how it affects landlords in general and what your mortgage options are going forward.
- What is the mortgage credit directive?
- Mortgage credit directive: what are the new rules for landlords?
- Why were these regulations changes brought in?
- How does the mortgage directive affect landlords?
- How rent cover impacts borrowing
- What are my mortgage options as a landlord?
- Summary
What is the mortgage credit directive?
The Mortgage Credit Directive came in to force in March 2016 to ensure all states in the European Union (EU) make sure mortgage lenders apply borrowing rules uniformly.
Most EU states already regulate mortgages, but the rules vary and few lenders are active across borders. The new rules aim to open a European-wide mortgage market where borrowers can expect the same treatment wherever the lender is based.
Mortgage credit directive: what are the new rules for landlords?
The mortgage directive divides buy-to-let borrowing in the UK into consumer and commercial buy to let.
Consumer buy to let
This is a new mortgage concept for 'accidental landlords', which is defined as someone who didn't buy the property to rent it out but has done so due to their circumstances. These landlords generally have only one letting property, which they either inherited or used to live in.
The aim is to make sure new landlords can afford to take out a mortgage against a rental property. The directive lays out a set of tests defining an accidental landlord.
These tests cover where a borrower:
- is taking out a loan to purchase a buy-to-let home for the first time
- has already bought or inherited a home to rent out, but neither the borrower nor one of their relatives has lived there
- already has one buy-to-let home rented out on a tenancy agreement
Commercial buy-to-let
A commercial landlord is regarded as a buy-to-let investor who already owns and rents out several homes.
The difference between consumer and commercial buy-to-let mortgages
Commercial landlords continue to have their borrowing treated as business lending. This means consumer protection rules under the mortgage directive do not apply to them.
Consumer buy-to-let lending has similar safeguards to other homeowners, such as access to an ombudsman to deal with complaints.
The main difference between the two lending categories is consumer landlords face a stricter affordability test.
As before, commercial landlords need to pass the 'rent cover' test that generally expects the rent generated by a buy to let to come to at least 145% of the mortgage interest payment at around a 5% interest rate.
Consumer landlords don't have to pass the rent cover test. However, they have to show they can cover the mortgage payments from their disposable income – much in the same way as they do for other borrowing.
At the time of directive's launch, the government predicted the new rules would impact around 11% of buy-to-let mortgage borrowers who are accidental/consumer landlords.
Why were these regulations changes brought in?
One of the key reasons for the consumer landlord rules is 'mortgage gaming'.
As buy-to-let borrowing has laxer underwriting rules, some homeowners have taken out buy-to-let loans and moved into the property because if they tried to take out a normal home loan they would fail the affordability tests. Mortgage gaming is fraud and the new measures are a bid to stop borrowers making false claims about living in a buy-to-let home.
The changes shouldn't bother landlords who already have two or more homes rented out. They will continue to take on new borrowing as commercial landlords.
Consumer landlords will move up to become commercial landlords automatically as they buy more homes to rent out.
In 2016, the Department of Communities and Local Government's English Housing Survey indicated around 20% of all homes in England and Wales are private rentals. That is more than 4.5 million properties.
According to trade body The Council of Mortgage Lenders, 62% of landlords own a single rented property. Only 7% own five or more homes to rent.
How does the mortgage directive affect landlords?
One potential implication of the mortgage directive is fewer accidental landlords may qualify for a buy-to-let mortgage because they will fail the affordability test.
Policies like the consumer landlord rules, cutting mortgage interest tax relief for higher rate taxpayers, and extra powers handed to the Bank of England to limit the size of buy-to-let loans look like a joined-up policy to rein in the market. However, the government has not commented to confirm this approach.
How rent cover impacts borrowing
Rent cover rules determine how much a landlord can borrow to buy or remortgage a rental home. Until January 2017, rent cover was calculated as 125% the monthly gross rent at an interest-only rate of 5%. If the monthly rent matched or was more than this, then the loan was generally approved.
Towards the end of 2016, the Bank of England ordered buy-to-let lenders to look at adjusting rent cover to 145% of the monthly rent.
This means many landlords are now mortgage prisoners as they cannot refinance their homes to a lower rate or raise any extra cash from a property.
Here's an example of how the rent cover change might impact a landlord:
| A | The property worth | £170,000 | |
| B | Monthly rent | £750 | |
| C | Interest only mortgage rate | 5% | |
| D | Mortgage required | £127,500 | |
| Could this landlord get a mortgage charging £750 a month on rent? | Under the old rate of 125% | Under the new rate of 145% | |
| E | Annual interest only mortgage cost (Row D multiplied Row C) | £6,375 | £6,375 |
| F | Monthly mortgage cost (Row E divided 12) | £531.25 | £531.25 |
| G | Rent required to cover mortgage cost (Row F x Rent cover rate) | Mortgage Approved £664.06 | Mortgage Declined £770.31 |
Under the old rent cover rules (125%), the rent supported the borrowing and the mortgage would likely be approved. But under the current rent cover rules (145%), the rent fails the test and the mortgage amount the lender would advance would be reduced. This would mean the landlord would have to find a larger deposit.
For remortgages, landlords failing the new rent cover test would have to pay down their mortgage to qualify for a cheaper interest rate.
In the worked example, the mortgage advance would drop by around £3,825 to £123,675 for failing the 145% rent cover test.
What are my mortgage options as a landlord?
Commercial landlords need not worry too much as mortgage borrowing should continue much as before the directive starts. Some other borrowers may face different borrowing rules.
Here's a breakdown of who it does and doesn't affect.
Limited company buy-to-let mortgages - companies are unaffected by the directive as their borrowing is considered commercial.
Homeowners switching from a residential to buy-to-let mortgage – these are likely to be treated as consumer landlords unless they already have a portfolio of letting property.
Changing a buy-to-let mortgage to residential – homeowners switching from renting to living in a former buy to let will have to follow the mortgage directive rules.
Buy-to-let mortgage first time buyers – first-time buy-to-letters will come under consumer buy-to-let rules.
Buy-to-let remortgaging for accidental landlords – buy-to-let remortgages will come under the mortgage credit directive. This may mean lenders will turn down applications from consumer landlords who previously qualified for a buy-to-let mortgage.
Holiday lets and second homes – mortgages for holiday lets will remain commercial borrowing, while those for second homes are personal borrowing and come under the directive.
It's also worth reading about mortgage interest tax relief when thinking about investing in buy to let.
Summary
Consumer landlords renting out a home they have lived in or inherited will face stricter borrowing rules and may find they cannot finance a property to rent without putting down a significant deposit.
Despite the European Mortgage Directive, commercial landlords should find financing buy-to-let homes business as usual, even though the amount they can borrow is likely to fall.
Steve Sims
Added: 17th August 2017