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BTL Regulatory Changes.

Here you will find any regulatory changes that have come from the PRA (Prudential Regulation Authority) and the FCA (Financial Conduct Authority).

 

Lenders Buy to Let Matrix

Lenders have been busy implementing changes and all the details have been updated on our Buy to Let Matrix, which can be found here.


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NEW UNDERWRITING PROCESS FOR PORTFOLIO LANDLORDS

As set out in the Prudential Regulatory Authority’s (PRA) Supervisory Statement 13/16 Underwriting standards for buy-to-let mortgage contracts, lenders will be required to adopt a specialist underwriting approach for Portfolio Landlords, e.g. those landlords with four or more mortgaged buy to let (BTL) properties. This new approach should be in place by 30 September 2017 at the latest.

One of the reasons behind the new process is that the PRA has found that the rate of arrears increase as a landlord’s BTL property portfolio increases.

The PRA does not prescribe exact requirements but provides guidance, which includes:

  • The lender’s knowledge of the borrower
  • The borrower’s experience in the BTL market, their full portfolio of properties and outstanding mortgages
  • The borrower’s alternative sources of income, assets and liabilities, including any future tax liability on rental income
  • The merits of any new lending, taking into account their existing BTL portfolio, together with any business plan, and
  • Historical and future expected cash flows associated with all the borrower’s properties

In summary

Portfolio Landlords may experience a tougher process on their next BTL purchase and find that the new specialist underwriting process requires a lot more information.

CHANGES TO TAX RELIEF FOR RESIDENTIAL LANDLORDS

The tax relief that landlords of residential properties get for finance costs will eventually be restricted to the basic rate of Income Tax, this will be phased in gradually from 6 April 2017 and will be fully in place from 6 April 2020.

Some financial costs will still be deductible in the transition period. These will be gradually withdrawn and replaced with a basic rate relief tax reduction.

TAX YEAR  

% of Financial costs deductible from rental income

% of basic tax reduction
 2017 to 2018  75% 25% 
 2018 to 2019  50%  50%
 2019 to 2020  25%  75%
 2020 to 2021  0%  100%

 

The finance costs that will be restricted include interest on:

  • mortgages
  • loans - including loans to buy furnishings
  • overdrafts

Other costs affected are:

  • alternative finance returns
  • fees and any other incidental costs for getting or repaying mortgages and loans
    discounts, premiums and disguised interest

 

WHO WILL BE AFFECTED?

Those affected are:

  • UK resident individual that lets residential properties in the UK or overseas
  • non-UK resident individual that lets residential properties in the UK
  • individual who let such properties in partnership
  • trustee or beneficiary of trusts liable for Income Tax on the property profits

All residential landlords with finance costs will be affected, but only some will pay more tax.

Those who won’t be affected by the introduction of the finance cost restriction are:

  • UK resident company
  • non-UK resident companies
  • landlord of Furnished Holiday Lettings

They will continue to receive relief for interest and other finance costs in the usual way.

 

EXAMPLE         

The first tax year that finance costs will be reduced is 2017 to 2018. This example shows the withdrawal of 25% of finance cost deduction and given as a basic rate tax reduction.

Bob has employment income of £25,000 and rental income from residential property of £11,000 per year. His mortgage interest is £8,000 per year.

 Salary before Tax = £25,000 

  Property Income Calculations:

 Rental Income = £11,000 
 Finance Costs (£8,000 Mortgage Interest x 75%) = - £6,000 
 Other allowable expenses = - £5,000 
 Property Profits = £4,500
 Total Income = £29,500

  Income Tax calculations:

 £11,000 x 0% = £0 
 £18,500 x 20% = £3,700 
 £0 x 40% = £0 

 Less 20% Tax reduction for remaining finance costs calculated on 25% of finance costs

(£8,000 x 25% = £2,000) x 20% =

 -£400
 Final Income Tax =  £3,300

  The tax reduction is calculated as 20% of the lower of:

  • Finance costs not deducted (25% of £8,000) = £2,000
  • Property Profits = £4,500
  • Adjusted total income (exceeding Personal Allowance) = £18,500

The lowest amount us finance costs, so £2,000 x 20% = £400 Tax reduction

 

NEW BUY TO LET (BTL) UNDERWRITING STANDARDS.

The Prudential Regulation Authority (PRA) has agreed on a phased implementation process for the new BTL underwriting standards.

In their supervisory statement issued October 2016, lenders will be required to implement the affordability and interest rate affordability stress tests by 1 January 2017, with the remainder of the required changes by 30 September 2017.

For BTL applications, lenders will be required to determine:

  • 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
  • Whether personal income, in addition to any income derived from the property, is sufficient to support the mortgage payments using an income affordability test

When assessing affordability, future interest rate increases should be taken into consideration over a minimum period of five years, unless the rate is fixed for five years or more at the start of the contract, and the borrower’s refinancing risk at the end of the fixed/capped rate period.

The minimum ICR industry standard remains at 125%.

A minimum borrower interest rate of 5.5% must be used during the first five years of the BTL mortgage.

Portfolio Landlords (those with 4 or more mortgaged BTL properties) will be subject to a specialist underwriting approach based on their knowledge of the borrower, their portfolio, experience, assets and liabilities, cashflow and alternative sources of income.

Exclusions to the new standards include:

  • BTL contracts covered under MCOB (e.g. Consumer BTL contracts)
  • Remortgaging landlords where there is no additional borrowing
  • BTL contracts with less than 12 months
  • Consent to let where an owner occupier on a residential mortgage applies to let their property on a temporary basis
  • Corporate lending, including lending for mixed purposes (e.g. commercial real estate)

Some lenders have already made changes to their BTL calculations. To help you understand what lenders are currently offering we have produced a Buy_to_Let_Matrix (PDF: 166KB)   which will be updated over the coming months.

BUY TO LET TAXATION CHANGES

Are you aware of the up and coming taxation that were unveiled in George Osborne’s Summer Budget on 8 July?. These changes are being phased in from 2017 and fully implemented by 2020 and will have a significant impact on most landlords.

The current tax relief available on buy to lets has historically made them an attractive investment for any investor, however the new rules may make both new and existing investors think carefully when purchasing an investment property, in particular their tax position.

The current rules

Landlords can deduct qualifying expenses and mortgage interest from any profits gained before paying tax.

Tax relief is at 40% for a higher rate tax payer, and a top rate tax payer would receive 45% tax relief on their interest costs.

What is changing?


From 2020 Tax relief will be restricted to 20% for everyone - the reduction will be phased in over the four years.

The wear & tear allowance of 10% generally calculated as 10% of the gross rents will be abolished in April 2016 - Investors will only be able to deduct the actual cost of replacing furnishings in the tax year of the replacement.

This (especially as interest rates rise) for investors with significant levels of debt will see an overall significant increase in costs.

An example of this:

A top rate tax-payer owns an investment property worth £2m financed by a loan of £1.2m with interest charged at 3%. This generates a gross income annually of £80,000.

OLDNEW

TAX

INCREASE

Income  £80,000  £80,000  
 Wear & Tear  (£8,000)    
 Less loan interest  (£36,000)    
 Taxable profits  £36,000  £80,000  
 Tax at 45%  £16,200  £36,000  
 Less interest at 20%    (£7,200)  
 TOTAL TAX  £16,200  £28'800  £12,600

 

Other changes that may have an effect on the market are:

  • Current corporation tax is 20% reducing to 19% in 2017 and 18% by 2020.
  • An additional tax charge occurs on dividends and another change in the budget coming in April 2016 is every individual will have a tax free dividend allowance of £5,000. After that dividends will be taxed at 7.5%, 32.5% or 38.1% depending on whether the individual’s income falls into the tax bands.

STAMP DUTY CHANGES:


George Osborne made some significant changes to taxation for all second home or buy to let purchases in his budget this year.

The first of these changes is on stamp duty. Currently if you buy a residential home you pay stamp duty on the value, at a stepped rate that depends on the value of the property. You pay nothing on the first £125,000, then at each of four value thresholds a higher rate of tax is applied on the portion of the price above that level, up to 12 per cent on anything above £1.5m.

But from April 2016 anyone buying a second home or buy-to-let property will pay a 3 per cent surcharge on their stamp duty.

Stamp Duty Changes

property valuestandard ratebuy-to-let/second home rate from april 16
 Up to £125,000  0%  3%
 £125,000 - £250,000  2%  5%
 £250,000 - £925,000  5%  8%
 £925,000 - £1.5m  10%  13%
 Over £1.5m  12%  15%

 

Rate applies to that portion of the purchase price (2) Properties up to £40,000 are exempt from stamp duty. Properties between £40,000.01 & £125,000 will be charged stamp duty on the full purchase price.

*Please Note: This document does not constitute tax advice, investors should not rely on the information given and should investors have any concerns/queries then they should contact their tax advisor.

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