Proper Wealth EP 5: Buy to Let Mortgage Market - Liz Syms (Owner of Connect Mortgages)

Welcome to Proper wealth with me, Paul Mahoney, the show where we discuss all things creation, including property. Today we're going to discuss the buy to let mortgage market, some of the changes and how that's affecting the overall market as a whole. With me today is Liz Sims from Connect Mortgages. Welcome, Liz. Hi.

Thank you for having me.

Thanks for joining me, Liz. I think we should cover some of the recent changes. There's been quite a lot in the.

Market, just a few. That's an understatement.

And on previous shows we have discussed how that's actually affecting the property market. But I think we should also discuss how it's affecting the mortgage market and specifically the buy to let mortgage market. Given that this show is focused in on investments and wealth creation, perhaps we should go in chronological order and talk about how some of the changes are starting to affect the market.

Sure.

So if we start with the stamp duty premium, let's talk about that a bit more.

Yeah. Well, obviously what happened is the government decided they wanted to try and cool the buy to let market. So one of the strategies that they have adopted was to add an extra 3% stamp duty on every second home purchase with the aim to make it less attractive at the initial point for buy to let investors and hopefully make more property available to first time buyers. There was some unintended, I think, unintended consequences because as it wasn't just about buy to let, it was about second homes. So couples that had come together, for example, and were then looking to each had a property and they're looking to sell and buy but keep maybe one and let it out, they've been affected as well. So even people buying their own residential home in some cases have been affected by this second property tax and also.

Upgrading and keeping their first home. Exactly that as well.

Exactly that. And I think that's, that's had a bit of an effect on the home mover market. So whilst it's had the desired effect with more first time buyers, the actual home mover market has slowed. So not sure whether that was totally the consequence they were looking at. But there are some things that landlords can do or look at. So for example, if they look to extend the sorts of properties they'll consider into the commercial market, that doesn't apply. The extra stamp duty doesn't apply in the commercial market. So it means they can still buy a 250,000 pound commercial investment and let it to a business rather than an individual and only pay £2,500 in stamp duty as opposed to £7,500. So that's one of the strategies we've seen our clients adopt.

It also applies to mixed use property.

Absolutely.

For example, a shop on the ground floor and a flat above.

Yeah. And that's a great way for somebody that's used to just doing buy to let mortgages to actually get into the commercial market. It's a softer entrance where there's some elements of buy to let mixed with the retail, the shop for example.

And with that shift, I suppose with more people potentially looking to avoid that stamp g premium potentially investing more in commercial or mixed use, I suppose that's resulting in more demand in that area from, from a mortgage perspective.

Yes, yeah, absolutely. And so mortgage advisors like ourselves that you know are involved in that market are seeing more and more inquiries. However, I think for most buy to let investors, there are some definitely that are going down that route and see commercial for other reasons as well as beneficial, which will cover off. But I think for a lot of buy to let investors, it's also very much, well, okay, this is a cost I'm now going to wear and that one is the stamp duty one is now pretty much business as usual. And whilst it's still a better pill, it's kind of been forgotten about a bit with all of the other changes that have now come into place.

Well, I suppose if an investment doesn't stack up and have more of a buffer than 3% in the first place, it's probably not worth making anyways.

I agree. Yeah. You know, if the 3% is something that's going to put somebody off, it probably isn't a great investment if it doesn't stack up. Including that 3%. Absolutely.

Well that's interesting to see how that stamp duty premium is affecting both property and the mortgage side of things. Have you seen commercial mortgages sort of come down in rates or more products become available at all because of that?

Absolutely. There are new entrants into the commercial mortgage market. You've typically got two camps in the commercial market. You've got your high street commercial lenders, so your big high street names that everybody will know. And then you've got what we call the challenger banks. So where the high street will maybe just do a repayment mortgage, maybe low loan to value 60%, the challenger banks will come in with interest only, more flexible terms and will potentially look to 70, 75%. And there's more of those that have come into the market fairly recently. So it's an interesting time.

Yeah, that's interesting. Okay. Alright, so We've covered stamp duty or the stamp duty premium.

Yep.

Then we had section 24. We have section 24 starting.

The start of it. Yeah.

Starting to now come into play. What changes have you seen that cause on the mortgage side of things?

I think the first thing is, obviously it affects anybody that holds a property in their individual name. They will no longer be able to fully offset all of their mortgage payments against their rental income for tax purposes because the tax relief will be restricted to 20%. So as they are a higher rate taxpayer, they are effectively going to be paying more tax on their properties. It can also affect basic rate tax payers who will still get that relief. But the way it's calculated, it can push a basic rate taxpayer into the higher band. So it can cause an effect on that and on benefits and things like that as well.

My understanding in that respect is it's your, your employment income plus your property income.

That's correct.

That will determine your band, but it's.

Your gross property income because of how the calculations actually work. So. So it's being phased in as you know, over the next four years. So this is the first year. So I think landlords are aware of it, but they actually haven't seen how that's going to affect their pocket as yet. So there are some tools on the government's own website where people can put in what number of properties they've got, what their tax band is and what their income is for it to give some kind of indication of what they can expect, which I think every landlord should be looking to do. But there are some other strategies that some of our landlords are using in relation to limited company purchases because they will still be able to benefit from the actual full offsetting of the mortgage interest. Yeah.

I read an interesting stat recently actually that said that before Section 24 was announced, only 5% of buy slip mortgages were for limited companies.

Yes.

And in the final quarter of last year, nearly 70.

Yeah.

Massive, massive difference there, isn't it?

I think it is, it is a massive increase. It has become a very popular way. But really you need to look at it that, that 70% is actually mostly about purchases because if you take both purchases and remortgages, the limited company percentage drops because you can't remortgage from an individual name into a limited company because they're two separate entities. So it has to be a sale and purchase between the two of them.

And that's quite costly, isn't it?

That can be. If people don't get the right tax advice and they really need to capital.

Gains tax and stamp duty, stamp duty.

At the higher rate and so on. So there are ways that people can navigate through that if they get the right advice. But any new purchases, those are the ones we've seen where it's gone massively towards the limited company route.

Absolutely, yeah. And I suppose certainly what I've seen is that's been mostly the people on the higher tax brackets that are worried about close to the higher tax or very close. Yeah. Okay, that's interesting. And have you seen that affect the limited company buy select mortgage market?

Yeah. So prior to this happening, there was a premium for limited company. So a lender might charge 1% more if you were buying through a limited company than if you're buying through your individual name. But because there's now more competition for that type of deal, more landlords are actually looking at doing this and lenders want to win business. We've now seen most lenders where actually whether you're buying an individual name or whether you're buying a limited company name, the pricing is the same. So there's greater competition, better pricing for limited companies and again, more lenders coming into this market to take advantage of so they can get some more market share from that.

Yeah, that's interesting. I suppose before it was a niche, wasn't it?

Yes.

And now with so many more products, so much more competition, those that those rates have come down or the ability to charge that premium has come down.

Starting to become more mainstream. Absolutely, yeah. Okay.

And from the perspective of the amount of people investing through the major companies, in your experience, what do you think the ratio is there so far as people buying in their own name and buying through limited company?

Well, I think through new purchases, as you highlighted, definitely, you know, probably a good 70% are buying, but, you know, if you've got somebody that's just got one or two properties and they're in the lower tax band, then a limited company may not be the right route for them because there are costs to running that limited company and how it's taxed and how you can access your money from the limited company are also things that people need to consider.

Absolutely.

So it isn't right for everybody. But that's why I come back to saying go and get proper tax advice. Because once you've got the mortgage in place, either individually or in a limited company, it's quite hard and costly to change it. So getting that advice and doing it right before you buy is absolutely key.

I think the common Theme throughout this show has been getting advice is key in anything you're doing in what are fairly life changing decisions. You know, property is a large purchase. It's generally one of the largest purchases people will ever make. So doing that right is pretty important.

And it might not be your local accountant that normally does your business books that is the right person to get tax advice about property from. That's a very specialist area.

That is a really good point because there are lots of accountants that aren't even necessarily familiar with these changes. So understand understanding property specifically would be quite important.

Yes, definitely.

Excellent. Thanks very much, Liz. Join us after the break for more discussions on the buy to let mortgage market changes and how that's affecting property overall. Welcome back to Proper Wealth. Today we're discussing the buy schlep mortgage market and my guest is Liz Sims from Connect Mortgages. So before the break we discussed the stamp duty premium changes, the section 24 and I think now we should discuss the PRA changes.

Okay.

And the two sides to that, how that's starting to affect the market because they're quite recent changes, aren't they?

Absolutely.

So perhaps if we start with the change that occurred in January of this year.

Yes, yes. So pra, Prudential Regulated authority. Are the party that regulate the lenders or certainly some of the lenders, any of the lenders that take retail deposits as part of their funding, they're regulated by the PRA and the other lenders are regulated by the FCA and they were tasked by the government to again look at ways of calling the buy to let market. So that didn't cause another credit crunch of sorts in the buy to let market. So the first topic that they decided to tackle was the affordability side of things because we've already talked about the stamp duty and the tax. The tax is likely to increase people's costs on their buy to let going forward. We're at a low interest rate environment at the moment. So. So that's only really got one way to go. So they just wanted to make sure that as costs start to go up in the buy to let market that that had been factored in. So in January they bought in the first of the rules relating to the affordability and so set in stone that lenders need to make assumptions that the interest rate rise is going to go to five and a half percent and that the rent can cover payments at a five and a half percent interest rate rise. And then on top of that to factor in additional costs of running the portfolio like the extra Tax costs and rental voids and management fees and things like that. And that's when you get that additional margin.

Right.

The PRA were very prescriptive on one part of that, which is they have to calculate what the interest costs would be at 5.5%. But the margin part of it, for voids and costs, they left for lenders to make a decision on. And that's why you see a variable where some lenders want 125% coverage, some want 145 or 150, because they're all interpreting themselves, making brokers lives difficult, making brokers life difficult, because they're all interpreting themselves what that margin should be in certain circumstances. So if somebody is buying through a limited company and won't be affected by the tax, the lender's going, okay, we won't need such a big margin and maybe we can go for 125. Whereas somebody's still carrying on and buying in their individual name. They're going to be affected by those tax changes. So therefore they'll want a higher margin in place.

Okay, Right. And it's been interesting to see how that's affected how much people can now borrow.

Yes.

Whereas certainly in London and the south east previously it was quite easy to borrow, you know, 75% and now it seems to be more like 50 or 60% being the maximum. In lower yielding areas.

Yeah, definitely in lower yielding areas it can restrict the maximum loan to value, but there are things that landlords can do. So the rules allowed for lenders to use a different calculation in certain circumstances. One would be if the interest rate was being fixed for five or more years, because on that basis those landlords are not going to be affected by the rising interest rates. So we've got lenders, for example, with five year fixed rates around the 3.5% mark, they're allowed to do the calculation based on that three and a half rather than five and a half. So that is one way to look at it. There are other lenders that do what we call top slicing. So they're saying if the rent doesn't fit, then actually we'll look at your income and if you have some surplus income, we'll use that to make up the shortfall. So there's a couple of innovative things that some of the lenders have come out with to help navigate through that particular piece as well, I suppose good.

Reason is seek advice.

Yeah. And absolutely. Coming back to one of the reasons people were looking at limited companies was from a tax point of view, but actually because the lower rental calculations for a limited company, that's the second reason why limited companies are actually popular as well.

Okay, that's interesting. Okay, so we have that serviceability change or your extra regulations around serviceability. Do all lenders need to follow that?

No, because the PRA just regulates those deposit taking lenders, although the ones that are regulated by the fca, they've been directed to follow the pra, but there's still a small number that sit outside of the fca. And these are the lenders that just offer buy to let. So they don't fall into the regulation with the FCA because they're not doing a residential offering, they're only offering buy to let. So they have the flexibility to actually offer rental calculations that are slightly different to the mainstream lenders that are affected.

By specialists buy to let lenders.

Definitely some specialists, some of the newer lenders and so on and so forth. However, some of them may have a parent that is regulated by the FCA or they may be looking to get regulated by the FCA or the PRA at a later point. So therefore they don't really want to go to too far beyond. But it's a useful tool to know if a landlord does need a little bit of flexibility on those rental calculations, which lenders are able to offer.

Okay. Yeah. It certainly seems like all these changes are making things quite a bit more complex in what up until quite recently, I would say was quite a DIY type industry, property investment in general. People go on Zoopla, they find a property they like, they buy, and then they go to their bank to get a mortgage.

Yeah.

Quite that simple anymore, is it?

No. I'd like to say that everybody needs to get advice from a specialist mortgage advisor who can actually help them navigate through this because there are a lot of choices and options.

Okay, excellent. All right, so we covered the first PRA change now, and now the most recent.

That's the easy one.

That was the easy one. Now the more recent one. Very, very recent. Yep. Let's talk about, about the portfolio landlord changes.

Yeah. Okay, so just to be clear, the first change affected every landlord. Okay. So regardless of how many properties, if you only got one property or if you got 100 properties, you were affected by that first change. The second change, however, only affected what they called portfolio landlords. The PRA identified that anybody who had a portfolio are likely to be more at risk from some of these tax changes and other changes in the marketplace. So then they defined what a portfolio landlord is, which is basically anybody with Four or more mortgaged buy to let properties.

That's an interesting point. Let's just touch on that.

Yes, sure.

So if you have two mortgaged buy to let properties and three unmortgaged ones, does this change affect you?

No. Because you're not classified a portfolio landlord unless they all four, including the one you're trying to finance, are mortgaged.

I think that's interesting to clarify in that the way these changes are worded, a lot of the time people tend to get a little bit confused, I think, or get misconceptions. So that's an interesting point.

The other thing to bear in mind though as well is unfortunately, in this circumstance, the limited company piece doesn't get you out of the portfolio change. So if you hold a property as a share of a property, jointly with somebody, or because you've got it inside a limited company and you're a shareholder or director of that company, that is counted towards your four, but your main residence is not counted towards your four. So once you sort of understand that, then you can look and see whether actually are you affected by this portfolio landlord or not.

You know, to me, that change actually makes quite a lot of sense. I think a lot of landlords are a bit wise worried about it. I think everyone's worried about change in general, but so far, as a lender assessing your whole portfolio rather than just the one they're lending on, in that you could have one great property you're buying now and three terrible ones. Of course, those three terrible ones are going to affect the success of the one you're buying overall or your financial situation anyway. So it kind of makes quite a lot of sense. It's pretty sensible, I think.

Yeah. So effectively what the PRS said is if you identify somebody as a portfolio landlord, you need to apply specialist underwriting, which means you have to look at the whole circumstances, not just the subject property that's being financed. So what that means is actually we've now got two rental calculations, so we have the first rental calculation being done in the way that was brought in in January. But now the lenders are also having to, what we call stress test the background portfolio and say if the mortgage interest on the background portfolio was to increase, will the rent payments still cover it? So you could have a situation, as you've just highlighted, where the subject property is absolutely fine, but the background portfolio doesn't meet those requirements of the lender and therefore they can't lend. But they were also directed to do things that like look at somebody's strategy and their business plan. So how does that new property fit in with the background portfolio actually? Does it enhance the situation? And also to look at how the landlord is going to be able to cope in the future with things like changes. So the lenders are sometimes asking now for cash flow projections, for example. But it's interesting that again, there's some flexibility around this. So the PRA have made suggestions, but they haven't made black and white rules. So you're getting lots of different interpretation again, lender by lender, which means whilst one lender might say no, it doesn't fit for us on the background portfolio, the next lender might say, the way we calculate it, it works.

Okay, so it seems a lot of these chains are looking to professionalize the buy to let market. Certainly more reason to get the vice given the extra complexity and I suppose probably more importance on yield than previously.

Yeah, I think so. But there are still some investors, as you know, that look to purchase certain properties for growth more than yield. Where lenders can actually accommodate, that is they can ask for also an asset and liability statement. So if a background portfolio or a subject property is not potentially performing as you know, the stress test would dictate it should if the landlord has got other assets, maybe commercial property, because that sits outside of all of these rules, or maybe some investments in stocks and shares so they can demonstrate that they can weather the storage of the, you know, increased tax costs or rates and so on.

So essentially different ways around it, different ways of dealing.

Lenders can take that view with the right sort of flexible lender.

Excellent. Well, that's all we've got time for now, but there was some great points there. You know, I'm sure a lot of our viewers learned an awful lot from that chat. Thank you for joining us on Proper wealth with me, Paul Mahoney. Join us next time for more discussions on wealth creation, including property.

Sam.