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Affordability testing and interest rate testing

The Prudential Regulation Authority (PRA) announced on the 29th September 2016 its expectations of lenders’ underwriting standards to apply to the buy-to-let market, following a review of the market in 2015/2016. These changes were implemented on the 1st January 2017.

What these changes will mean for you and your clients:

Affordability testing

• Affordability testing will become mandatory; using an interest coverage ratio (ICR) test and/ or an income affordability test.
• Affordability assessments should take into account: borrower’s costs including tax liabilities, verified personal income (where used by the lender) and possible future interest rate increases.
• If non-rental/ personal income is used, lenders will be expected to conduct a detailed affordability assessment of the borrower taking into account income and expenditure, credit commitments, essential living costs and other commitments.
• The PRA wishes to clarify that the provision in Capital Requirements Regulation (CRR) which reduces the capital requirements on loans to small and medium-sized enterprises by around 25% should not be applied where the purpose of the borrowing is to support buy-to-let business.

Interest rate stress testing

• Lenders will take future interest rates over the next 5 years into consideration to ensure sustainable affordability testing unless the mortgage is fixed for 5 years.
• The minimum interest rate used in the stress and affordability tests should be 5.5% or a 2% increase above the current buy-to-let rate, whichever is higher.

Things to consider

• The PRA’s consultation paper issued on the 29th March 2016 clarifies that the changes announced in the supervisory statement will exclude landlords remortgaging (and not increasing borrowing) in a similar way to residential lending.
• Lending to portfolio landlords (defined by the PRA as being those with four or more mortgaged buy-to-let properties) should be assessed using a specialist underwriting process.

Here to help

For more information, call us on 01702 538 800 or request a call back.