Financial regulators at the Bank of England are putting together plans for a stricter regime for buy-to-let mortgage lending over concerns that the housing market is overheating. The Prudential Regulation Authority (PRA) at the central bank has opened a consultation on its newly published proposals, which include tougher affordability tests for borrowers.
According to the PRA's consultation document, the new rules would reduce the number of new buy-to-let mortgage approvals by between 10-20% by the end of 2018. Some lenders would not be able to recover the lost future revenues, it added.
"The proposals seek to ensure that firms conduct their buy-to-let business in a prudent manner," said the PRA. "They aim to prevent a marked loosening in buy-to-let underwriting standards and to curtail inappropriate lending and the potential for excessive credit losses."
Low interest rates and high house prices are giving the Bank of England cause for concern. At some point in the future, policymakers will raise the base rate from its all-time-low of 0.5%, where it has sat since 2009 to stimulate the economy as it recovered from the financial crisis. Cheap mortgages allow homebuyers to take on bigger mortgage debt, posing a risk when the central bank increases interest rates.
In particular, Bank of England Governor Mark Carney has warned about the buy-to-let market, which he said needs "heightened scrutiny". Property investors have cashed in on the housing shortage and are making bumper returns from the resulting capital growth and high rents. But many of those investors are heavily indebted and at risk of an interest rate shock.
One of the PRA's proposals is that lenders take into account the borrower's ability to cope with a 2% increase in interest rates. "Even if...the borrower's interest rate will be less than 5.5% during the first five years of the buy-to-let mortgage contract, the [lender] should assume a minimum borrower interest rate of 5.5%," said the PRA.
The buy-to-let portion of the mortgage market is rising. As of the fourth quarter of 2015, it accounted for 15.9% of all mortgage lending, said the Bank of England, equivalent to £10bn ($14.3bn, €12.7bn) and the highest it has been since 2007 when the data begins. By comparison, first-time buyers accounted for 20.9% of the market, or £13.2bn.
Chancellor George Osborne has hit the buy-to-let sector - which has boomed since the mid-1990s - with a number of tax increases as part of his effort to increase home ownership. Osborne wants to cool buy-to-let investment to stop them crowding out first-time buyers in the competition for property. There is a housing shortage in some areas of the country, particularly London and the south east of England, which is driving up house prices.
"The Bank needs to be careful that it does not overreact to the current surge in buy-to-let applications which are aiming to beat the tax increases coming in April," said David Smith, policy director of the Residential Lettings Association (RLA). "These include a three percentage points extra levy on stamp duty and abolition of mortgage interest relief. It is likely that the impact of these will significantly reduce the demand for borrowing. We would urge the Bank to tread carefully and avoid any premature moves that could stifle the supply of the one million rental properties the country desperately needs."
Regulators have already tightened the owner-occupier mortgage market. Following its Mortgage Market Review in 2012, the Financial Conduct Authority imposed stricter affordability tests on borrowers. The Bank of England also told lenders they can only comprise 15% of their net new mortgage lending of loans worth 4.5 times more than the borrower's' income.