• 3 key changes which Landlords need to think about.
• 2 need to be prepared for over the next 12 months.
• 1 has the potential to make it very difficult to continue as a landlord.
Back in February of 2016, we posted a blog called “Is Buy to Let Still a Good Investment?” when the Stamp Duty Land Tax changes came out, but a lot has happened since then, so we decided to revisit the question and give you some tips on how to survive as a landlord in the changing world.
Over the past year there has been a lot of conversation and speculation over the fate of the Buy to Let market and there are now a lot of things to consider if a good return is going to be made from property investment.
in January 2016, the Bank of England stated that the vast success and size of the private rented sector could pose a serious threat to the UK economy, among their concerns was the idea that due to the scale of the market, a sudden rise in interest rates could push a significant portion of landlords to sell their property in droves and therefore cause house prices to fall and begin a knock-on effect that would negatively impact the wider economy.
Since then, a number of changes have been introduced that have had a big impact on both professional and prospective landlords.
We’ve put together this article to demystify these changes, outline how they might affect you and suggest what you can do to survive and thrive in the Buy to Let market of today and tomorrow, so let’s get started:
Stamp Duty Charge on Buy to Lets and Second Homes
It is nearly a year since the additional 3% stamp duty land tax charge came in to force for second and subsequent properties, this created an additional cost to entry on the Buy to Let market and rendered some investments financially unviable.
New investment in Buy to Let properties has since, as predicted, fallen significantly; which appears to have been the government’s intention when the increase in stamp duty was proposed.
You can find a breakdown of the stamp duty rules here, and use our stamp duty calculator here. Remember that if you want to be sure whether you will have to pay the higher rate, you need to speak to your solicitor.
The New Buy to Let Tax Rules
But the government did not stop there, Income Tax Relief changes for mortgage interest payments on Buy to Let properties means many people are going to start finding the amount of tax they are charged may increase significantly over the next 4 years; and it’s not only for those who are high rate tax payers, the change is going to affect many people.
If you are a Buy to Let Landlord, whether you have one or two properties or a large portfolio, now would be a good time to discuss the changes with your accountant and see what they will mean for you; this should give you sufficient time to think about how you will deal with the changes and avoid any nasty unexpected tax bills in the future.
Buy to Let Mortgage Affordability and Stress Testing
The third challenge which has also already happened but is not yet widely understood is the Prudential Regulatory Authority rules which have been implemented by lenders which require them to stress test rental income at a higher level than previously.
What this means in practice is that not only will there be an additional barrier to entry for people purchasing investment property, it also becomes harder for landlords to refinance some property due to the fact the calculation originally used to obtain mortgage finance has changed and they may now be declined on the grounds of affordability.
To get an idea of how much rental income you’ll need in order to borrow your desired amount, you can use our calculator here.
People who should watch out for this are borrowers with tenants who pay lower rents than the actual market value, and people who are borrowing at the upper end of the old affordability model. If you want to check where you stand, most lenders have moved to the following stress test formula:
Loan amount X 5.5% X 1.45 = annual rental income required
Let’s see how this new formula works out for a landlord who takes an annual rent of £6600 on his property that has £100,000 of borrowing secured on it, this loan would most likely have passed the lenders stress test before the changes came into force.
But now this is what is likely to happen.
£100,000 X 5.5% = £5,500 x 1.45 = £7975 (required annual rent for the loan).
As we can see, this borrower’s annual rent falls short by £1375 under the new rules and they will therefore find remortgaging this property a challenge. A select few lenders may still lend the money needed by taking account of the borrower’s additional income, but the choice is going to be very restricted, which also means they may not get as good a deal as they might have hoped.
This test does however have less effect if borrowers are prepared to take on longer term fixed rate deals for 5 years or more. However while longer term fixed rates offer stability, the down side is they are more expensive and are less flexible than the short term 2 year fixed rate and tracker product which many landlords use.
The problem is that landlords are now caught between a rising stress test and higher tax charges. This is all arriving at a time where many 2 year deals are maturing and some older landlords are relying on rental income as retirement income.
On top of this there are many landlords who are sitting on very low cost tracker rates linked to LIBOR which were taken out before the financial crisis, what will they do when their mortgage term expires?
There is also a regional impact in areas where property does not attract a high level of rent, this could restrict borrowers from the opportunity of remortgaging and you could get stuck on your lender’s standard variable rate (SVR); this can be 6% or more.
We are already seeing landlords that are having to reduce borrowing levels on some of their properties in order to avoid being moved to the SVR or forced onto the longer term fixed rate.
What You Can Do to Survive in the Buy to Let Market
Use a limited company to own your property:
• Stamp duty and the income tax hike are avoided by using a limited company to own your property.
• There are of course costs associated with this method that you need to consider.
• Using this method, interest rates may be higher and number of available lenders will be restricted.
• The accounting requirements of a limited company are more expensive than those of an individual.
Paying off or reducing the borrowing on your current Buy to Let mortgage:
• Begin the process of needing to borrow less; but be sure to check the terms of the current mortgage as some Buy to Let mortgages do not allow over payments, always check with your lender or mortgage adviser.
• Remember that borrowing less will likely increase the level of tax charged on the profit from renting the property.
• More of your capital will become tied up in the Buy to Let property.
Increasing the rent:
• Many people think that reviewing and increasing the rent is a bad idea and in certain situations it may be better left alone, but it’s always good practice to at least review your rental charge, particularly if you haven’t done so in a number of years as you may be receiving a lower return for the risk you are taking.
• Putting rents up may help with the tax and borrowing stress test and mean you have to put less of your own cash into the property.
Review your investment; is Buy to Let still the best option for you?
• In some areas there is a high concentration of rental properties and this often brings an element of competition to the local market which damages rental income and could make your investment unviable.
• Consider whether your property has a bad energy rating; the regulation of the rental sector is likely to render properties with poor energy efficiency unlettable.
• Properties with a poor rental track record; if you have trouble hanging on to tenants, this might be a property worth letting go of.
Whatever your position currently is in the Buy to Let market, it is worth taking a step back right now and thinking about your situation, what options you are going to have in the future and how these key changes are going to affect you.
Ready to move in to the Buy to Let market or you’d like to review the finance on your current portfolio?
Get in touch with our experts and see what your options are with a free consultation, we have access to a vast range of lenders and can help you to navigate the mine field which is forming around the rental sector.