Further to our previous discussions around the withdrawal of interest relief, the additional 3% stamp duty and the impact of Brexit, we take a look at the effect of the Prudential Regulation Authority’s (PRA) stress tests and the benefits of incorporation.
Prudential regulation Authority Stress Tests
Since 2017, lenders have tougher rental cover tests, plus more questions for portfolio landlords.
The PRA has said that the minimum should be125%, but lenders should also take into account the borrowers future tax liabilities.
The Interest Cover Ratio is part of the basic affordability calculation that is typically applied to buy to let mortgage applications. The ICR is the minimum ratio between the expected rental income of the property and a notional interest rate
In reality the rent must cover at least 145% of the mortgage payment when the interest rate is at least 5.5%. This effectively means that every £100 of rent supports about £15,000 worth of borrowing.
There are some types of lending that these rules don't apply to. These are:
- Mortgages for limited companies
- Bridging lending
- Commercial or semi-commercial property
- Holiday lets
- Any loans with a fixed term of five years or longer
What do portfolio landlords need to provide?
In addition to the affordability testing outlined above the PRA expects firms undertaking buy-to-let lending to have regard to its potential business characteristics. The PRA considers that borrowers with four or more distinct mortgaged buy-to-let properties, in aggregate, should be treated as ‘portfolio landlords.
The PRA has suggested to lenders that they look at documents such as:
- Property portfolio spreadsheet
- Cashflow forecast spreadsheet
- Income and expenditure spreadsheet
- Business plan
- Three months' bank statements
- SA302s and tax overviews from HMRC
- Tenancy agreements for all properties
Malcolm - Kate what is your view regarding the stricter stress testing for landlords?
Kate - So, my view is, this is one of those things where I say to landlords, 'So, if you're coming up to a train crossing, do you think it's a good idea there's a barrier to alert you to the train crossing or not?' For me, the PRA stress tests are exactly that. They are that barrier, so that people don't get themselves into the mess that they did up until 2007 and borrow an awful lot more than they can really afford. So, for me, I think putting in those stress tests, although it's harder, it means that, to a certain extent we get more savvy landlords, who are then less likely to be repossessed. However, these and other changes to the buy to let business model have certainly suppressed demand and this in turn is suppressing price growth.
Malcolm - So generally you think that the increased stress tests are a positive introduction.
Kate - The problem with our market is it goes from boom to bust.
I remember the recession in the '90s, where, we had 90,000 repossessions in one year, I think. Even in this last recession, I think it went up to about 40,000. Maybe 45,000 at most. In normal days, even in the heyday, 25,000 would still be repossessed. So, if we can reduce the likelihood of repossession, particularly in the buy-to-let market, whereby a tenant can potentially lose their home and not have anywhere else to live, actually, I'm fairly supportive of these. I think it hurts in the short term, but I think it makes sense in the long term.
Malcolm - the rules are a lot more lenient on five-year fixes. So, a lot of people are doing five-year fixed rates. So, is it not just pushing the problem further down the road?
Kate - That's interesting. I suppose if they've got five years, would give them, potentially, some price growth and some rental growth, and therefore give them a little bit of extra cushion equity wise? I appreciate exactly what you're saying. It is though potentially kicking the problem down the road, but perhaps to a slightly safer environment, where they're more robust than they would be at the start of the investment - perhaps!
Malcolm - So, with all the recent changes in the BTL market, how have landlords changed. For example, are many of them seeking professional tax advice?
Kate – Sadly not. Most landlords have done absolutely no tax planning at all, mainly because people don’t want to pay for tax advice and think they can do everything themselves.
I always say the problem with buy-to-let landlords is that, one of the reasons they've got the money to do what they do is because they're quite tight. So, I hope I'm not offending anybody, but they're quite good with their money. So, if they inherit a bit or get a bit of commission, they don't go off to Florida and buy a Mini Cooper, they invest it in a house and then they go and get another one etc. The problem with that is they don't want to pay for advice. Therefore, they don't want to spend money on financial and tax advice, because they see that as a waste of money, not appreciating, the rich stay rich because they take tax advice.
Malcolm - If you pay a few thousand pounds for solid tax advice, this could pay for itself many times over, by reducing capital gains, stamp duty, income tax, inheritance tax etc.
Kate - Yes, I agree. I do think some people are getting more savvy about property now, and they're realising it's more long-term. They have realised it’s not necessarily the cash cow it was and they need more help to make sure it delivers a good return.
Malcolm – what are your views on landlords incorporating their portfolios?
Kate - I think that although people are looking to do it mainly to claim the mortgage interest relief, I actually like it for a different reason and that’s because when you're investing in property and your letting it out, it absolutely is a business, and by moving it into a business structure, I think that makes landlords more professional. I’m supportive of this, as its vital people take lettings and buy to let seriously and make sure they run it like a business, not consider it a ‘job on the side’.
Perhaps, when they're incorporating, they will now have a business plan ready, which for me is always essential. No-one investing in buy-to-let should do so unless they do two things first: have a business plan, and take tax advice.
Also, a company structure can be quite an effective way to pass on that business in the future.
In addition, we all know there are lots of landlords still taking cash payments, and not declaring it. So the more incorporated landlords running businesses, the more likely the right money will make its way to HMRC
I think, as far as landlords considering incorporating, my advice is not to listen to just anybody! You must speak to your own tax advisor, who's looked at your personal financial situation, aims and objectives and advised you accordingly. The issue is because what's right for person A is not necessarily right for person B, so you have to get one to one advice.