The buy-to-let bubble in the UK appears to have burst after being buffeted by tax and criteria changes.
The appetite for buy-to-let loans has waned since the controversial hike in stamp duty surcharge to 3 per cent on second and subsequent properties came into play in April 2016.
Council of Mortgage Lenders data shows there was an 82 per cent fall in the aggregate value of buy-to-let loans issued in the month before the change came to effect compared to £800m in January 2017.
It is worth noting the data is based on responses of the sample of participants of CML members. The CML gross data to account for the minority of companies that do not participate in its surveys.
There was an artificial hike in the number of buy-to-let deals completed in March 2016 as borrowers raced to beat the increase in stamp duty deadline. In numerical terms, the number of deals completed in that month was 29,100 – amounting to £4.4bn.
To put this into context, the value of the loan deals completed in March is almost triple the amount of the combined value of the previous two peaks from July 2013 (£1.6bn in July 2015 and October 2015 respectively).
The buy-to-let boom is juxtaposed by the subsequent radical dip in demand in April, to a measly figure of 4,200 – amounting to £600m.
Mike Richards, director at London-based Mortgage Concepts Associates, said: “The change to the stamp duty surcharge was a big deal. All of a sudden, owning more than one property became less palatable because of the heightened cost burden.”
Tax relief changes
Landlords’ returns came under increasing pressure in April this year, when HM Treasury began phasing in changes to buy-to-let tax relief.
Under the measure, mortgage interest tax relief will be limited to the basic rate of tax, currently 20 per cent, and given as a reduction in tax liability instead of a reduction to taxable rental income by 2020.
Pre-April 2017, landlords on higher incomes were able to deduct their mortgage interest costs from their rental income before calculating their tax bill.
Those paying higher rates of tax (40 per cent and 45 per cent) will see a significant increase in mortgage interest payments, under the new rules.
In other words, high income landlords will pay more in tax – particularly those with large mortgages.
Landlords who pay the basic rate of tax see no change per se – although with taxable income now calculated without a deduction for finance costs, some may find themselves pushed into a higher rate band as a result.
Aaron Strutt, product and communications director at Trinity Financial, said: “I think some landlords will consider selling their property as a result of the changes, but before they do anything, they should work out what their tax situation will be in the coming years.
“Many landlords do not know what tax they are liable for. These individuals should speak to an accountant to find out what their tax bill is going to be and a financial adviser before buying a property to let.”
On the affordability front, the Prudential Regulation Authority introduced rules effective in January 2017 to tighten underwriting standards following a consultation.
Highlights of the changes include the introduction of a requirement for lenders to stress test all new mortgages at a notional rate of 5.5 per cent, and factor in future interest rates when assessing affordability.
However, lenders are able to factor in the assumption for increases in rental income of up to 2 per cent – in line with the government’s inflation target – as part of the affordability process.
The PRA also stipulated special underwriting processes for landlords with four or more properties, which require them to disclose more information about their income in debts.
This ultimately translates to a substantial increase in work volumes, which may result in some lenders withdrawing their propositions for such landlords, according to David Whittaker, chief executive officer at Mortgage for Business.
The watchdog also said lenders should assume most future borrowers would be higher-rate taxpayers, which might mean lenders decline borrowers who are otherwise eligible today, according to Mr Whittaker.
He added: “Landlords may question why they have been asked to disclose more information than they did the first time round to secure a buy-to-let deal. A landlord’s tax affairs might be complicated.”
This has also resulted in lenders upping their rental income requirements to 145 per cent of mortgage interest rates from the standard 125 per cent.
Lenders have been trimming the rate of interest on a plethora of products, Ray Boulger, senior technical manager at John Charcol, said, adding: “In comparison, there have been no major movements in interest rates in the residential market in the past couple of months.
“The difference in rates in the residential and buy-to-let market have come down to around 60bps. A couple of years ago, rates on buy-to-let loans were between 150bps and 200bps in many cases.”
However, the more stringent affordability requirements mean that these discounted deals are out of reach for many borrowers, according to Mr Strutt.
He said: “If the borrower is seeking a low loan-to-value mortgage and the property has a decent amount of rent, there is a good chance of securing a remortgage deal. A lot of it depends on the location of the property. It may be difficult for properties in London and the south east to qualify.
“There are ways to get around the rental calculations. Some lenders allow borrowers to use their personal income as a top up for larger loans.
“Many lenders apply a generous rental calculation on five-year fixes. These loans have therefore increase in popularity as a result.”
The aforementioned changes to the buy-to-let space has resulted a shift in consumer behaviour, if observations by Mortgage for Business are anything to go by.
According to the latest iteration of the UK mortgage broker’s complex buy-to-let index, the first quarter of this year saw a greater adoption of smaller mortgages and cheaper properties. Meanwhile, figures for conventional properties are below any seen in the past year.
Landlords structured as companies fall outside the scope of both the changes to income tax relief and the PRA affordability guidelines, which have, according to Mr Whittaker, prompted many to consider incorporating.
Mortgage for Business reported 77 per cent of all buy-to-let applications were made via a corporate vehicle in the first quarter of this year – an “unparalleled high” according to the firm.
This compares to 69 per cent of applications in Q4 2016 and 21 per cent before the 2015 Summer Budget, when the tax relief changes were announced.
Mr Boulger said: “Putting a property into limited company can mitigate the changes, but not every investor wants to do that. There is definitely an education process to be had. Yes, there is a little bit of extra cost and paperwork involved, but it might be worth it. Borrowers would need to file accounts with Companies House and audit the company, but a lot of the process involves accounting that borrowers would be required to do if the property was under their own name.
“Buy-to-let investments through limited companies has got cheaper – in many case you can borrow more and higher earners can shield themselves from the tax changes.”
Some of the smaller yet notable changes to the buy-to-let space include the scrapping of the wear-and-tear allowance, which gave eligible landlords a 10 per cent tax relief on gross rental income on the cost of replacing furnishings.
Plans announced in the 2016 Autumn Statement to ban letting agents in England charging fees to tenants is a smaller, but still contentious, initiative for landlords, according to Mr Richards.
Letting agents are likely to circumvent the changes by levying landlords more. They will in turn pass on the cost to tenants by upping rents, Mr Richards said.
He added: “The combination of all these things has resulted in a notable slowdown in buy-to-let business for us. The changes have all-but killed the market. Estate agents are suffering the most because a lot of the housing market is fuelled by buy-to-let deals. I have heard through the grapevine that many of them are looking to lay off staff as a result of loss of business.
“I still think buy-to-let is a good investment strategy, but it is now pertinent for investors to assess their tax position before entering the market.”
Myron Jobson is a features writer of Financial Adviser
The appetite for buy-to-let loans has waned since the hike in stamp duty surcharge to 3 per cent on second and subsequent properties.
Lenders have been trimming the rate of interest on a plethora of products.
Letting agents are likely to circumvent the changes by levying landlords more.