This follows a review of the buy-to-let market in 2015/2016. The PRA’s actions are intended to guard against any slipping of underwriting standards during a period in which firms’ growth plans could be challenged by the changing economic landscape and the impact of forthcoming tax changes.

The PRA’s supervisory statement outlines minimum expectations that firms should meet in underwriting buy-to-let mortgages, including affordability testing, set to come into force in 2017.

Affordability testing

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.

When assessing the affordability of a buy-to-let mortgage contract, the PRA expects firms to use a method which will include:

• whether the income derived from the property is sufficient to support the monthly interest cost of the mortgage payments using an interest coverage ratio (ICR) test; and/or
• if firms are taking account of personal income as a means for the borrower to support the interest and capital (if applicable) monthly mortgage payments, whether that income, in addition to any income derived from the property, is sufficient to support the mortgage payments using an income affordability test.

For high net worth borrowers with annual net income of minimum £300,000, or net assets of no less than £3m, firms may use the borrower’s wealth in assessing the affordability for the buy-to-let mortgage contract.

Lending to portfolio landlords who have four or more mortgaged buy-to-let properties will have to be assessed using a specialist underwriting process.

The PRA clarified that the provision in Capital Requirements Regulation (CRR) which reduces the capital requirements on loans to small and medium-sized enterprises (SMEs) by around 25% should not be applied where the purpose of the borrowing is to support a buy-to-let business.

The implementation timetable will be 1 January 2017 for the interest coverage ratio (ICR) tests, including the impact of the personal tax changes, while the remaining requirements will have to be in place by 30 September 2017.

The PRA said that the changes should allow firms to assume reasonable rental increases when assessing affordability in the context of possible future mortgage interest rate increases. The measures exclude those re-mortgaging (and not increasing borrowing) from the supervisory statement, in a similar way to residential lending.

Reflecting the change to mortgage interest tax relief set to come into effect from April 2017, there has already been an increase in interest cover ratio affordability thresholds. The PRA has reaffirmed its expectation that firms should also take these new costs into account when assessing affordability.

The supervisory statement (SS) is relevant to all firms regulated by the PRA that undertake buy-to-let lending that is not already subject to Financial Conduct Authority (FCA) regulation.

In addition to the supervisory statement, the PRA has issued a policy statement which outlines the responses and any actions taken as a result.

The Bank of England has also published an article that provides the details of phase 2 of the loan-level data collection for buy-to-let lending, to be implemented from 2018 Q1 data.

The PRA will continue to monitor the buy-to-let market and how these standards impact new buy-to-let lending. The PRA will also consider a thematic review in early 2018 to assess firms’ implementation of this supervisory statement.

The PRA Underwriting standards for buy-to-let mortgage contracts - SS13/16 is available here