I spoke to The Times Bricks & Mortar journalist, Robin Ash, last week about the prospect of interest rate rises and how these might affect landlords. He thought it was paradoxical that there was a lot of activity in the buy to let lending market at the moment despite falling yields and the likely increase in lending costs. Latest NLA research backs up his sentiments that there is increased confidence among landlords. 62% say that prospects going forward are good and many ‘amateur’ landlords who use property income to supplement a day job or as part of a portfolio career, plan to add to their portfolio.
Mark Carney’s assertion this week that interest rates might rise sooner than the financial markets expected has taken many by surprise. The Chancellor George Osborne has also intervened by giving the Bank of England powers to restrict lending by Loan to Value – for example 95% of the value of the property – or Income Multiples, for example 4 times the applicant’s salary. I despair with what both of these key policy makers are saying.
First of all it is very difficult to have confidence in Mark Carney’s ‘forward guidance’ because he keeps changing his mind. In 2013, he signalled that rates would not change until unemployment fell below 7% which he didn’t expect to happen until 2016. Then when it fell sooner than expected – rates now stand at 6.6% – he said that this was just an indicator and rates would still be unlikely to change until the medium term. Projections published in the Bank’s Inflation report in May 2014 suggested a rate rise in Spring 2015 and yesterday he suggested that rates may rise sooner than that, with many now predicting a small rise in November or December this year. In his Mansion House speech, Carney said “to be clear, the MPC has no pre-set course. The ultimate decision will be data-driven.” So where was the data that supports his sharp change of opinion yesterday?
The new powers given to the Bank by George Osborne leave me equally bewildered. The government is supporting 95% mortgages through its Help To Buy scheme and at the same time has given the Bank of England powers to restrict high loan to value mortgages. Business Secretary, Vince Cable’s concern this week that some banks are lending five times annual salary was a precursor to the Chancellor giving the bank new powers to restrict income multiples. Given the Mortgage Market Review now requires lenders to assess applicants on affordability not income multiples, how do these policies fit together? Justin Urquhart Stewart described the chancellor’s intervention rather diplomatically on BBC Radio 4’s The Money Programme as “muddying the waters.”
So what does this all mean for landlords? Income multiples and restricted loan to values, if they were ever applied, would largely affect the owner occupier market. I suspect the main aim of these new powers is a shot across lenders’ bows to be more cautious. They may never actually be applied. Loan to values on buy to let are relatively low at 75%, with a few lenders offering expensive 80% and 85% loans, so I think it unlikely that these would be affected.
Just where are interest rates in the UK heading? I am business planning at the moment and I had factored in predictions that base rate would stay at 0.5% until the end of 2015, rise to 1.5% by the end of 2016 and 3% by the end of 2017. It now looks increasingly likely that we will see a rises in 2015 perhaps to around 1%. For those landlords who have taken out buy to let mortgages recently, they will currently be paying 3-3.5% above base rate on 75% Loan to value products. If you project forward on this basis then you would be faced with rates of 6-6.5% by the end of 2017 if you have a base rate tracker loan. However remember that the margin between bank base rate and payrates is very high at the moment. I think that this will narrow as base rates start to rise. Pre-2007 buy to let rates tended to be about 1.25-1.75% above base rate. I think that the margin will gradually lower as the base rate rises so that by 2018 we will have base rates of 3% and buy to let rates at about 1.5-2% above base rate. This will give a payrate of around 4.5-5% so not a lot higher than current rates. For those of us who have discounted rates pegged to the lenders standard variable rate, I think we will also see lenders raising the SVR by less than the rise in bank base rate. I think this will simply be a question of competitive pressures. The economy is improving, there will be more lending business and banks and building societies will want to maintain market share. I do not see a situation where buy to let rates will continue at base rate plus 3.5% when base rate is 3%. There is already evidence that mortgage rates are moving back to the historical norm. Best buy rates for buy to let are around 2.74% which is 2.24% above base rate. Among owner occupier rates, best buys of 1.48% have already edged towards the pre-2007 norm of 0-1% above base rate.
So is there nothing to fear from interest rate rises? Not if you have already bought in areas with good rental yields and capital growth. Landlords nursing negative equity or with low rental yields are most at risk. Some landlords have mortgage express loans, typically at base rate plus 1.75%, so base rate at 3% would result in a payrate of 4.75% which may still not be worth remortgaging. I think in 2018, we’ll be looking at best buy rates of about 4-4.5% for buy to let.
If you have negative equity, perhaps because you bought the property with a high loan to value mortgage and it subsequently fell in value, then you are a mortgage prisoner and may not be able to remortgage until your loan gets down to 75% LTV. This might be a concern if your current rate is at a high margin above base rate. If the rental yield is low – say below 5% – then once interest rates rise, the rental income may not cover your mortgage repayment. My advice would be to get your loan to value down to 75% as soon as you can, so that you will have the option to remortgage, assuming you fit lender criteria. Are you using rental profits to pay down the loan? Can you afford to switch to a repayment mortgage?
For the rest of us, make sure you have a healthy pot of savings to cover unexpected repairs, so that if your rental profits fall, you can still manage the portfolio properly. I also recommend stress testing cashflow over the next 3-4 years. Work out how your mortgage rates and payments are likely to change and how this will affect gross rental profits. It can take several hours to work this out depending on the size of your portfolio, but is very reassuring and makes for good sensible planning.
Advice is offered for guidance and to help you with your research. Always seek independent financial advice.
