Landlords And The Mortgage Credit Directive Explained

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Did you know that it used to be easier to get a buy to let mortgage than it was to secure financing for a home you intended to live in?  Lenders offering 1st charge refinance products, and 2nd mortgage loans are looking for generous coverage of the payments based on your after-tax income.

In 2014, many who were looking to take their first steps onto the property ladder stumbled upon a (sort of) loophole that the FCA perhaps missed, or didn’t think things entirely through. This fundamental statement in their 2014 Mortgage Market Review is what shook things up.

“Customers can borrow an interest-only mortgage as long as there is a credible repayment strategy”.

This was about the Consumer buy to let mortgage, known for short as a CBTL mortgage.

Furthermore, those went partially unregulated because the accessibility of them didn’t require an income assessment and strict criteria to be met because it only meant borrowers were required to indicate they could charge sufficient rental income to cover the repayment cost of the interest payments. The rest of the loan is secured against the property, thus providing lenders with surety.

Due to the open accessibility of interest-only payments, one broker reported a 46% increase in buy to let mortgage enquires. As you can imagine, eyebrows and questions were raised.

The answers revealed a worrying trend in the property market.

Mortgage Fraud

The Law Society advises solicitors working in the property conveyancing sector (and all others) that under the Fraud Act 2006, they can indeed be held liable for Mortgage Fraud, even if they weren’t aware of it because they should be doing due diligence to mitigate the risk of fraud being committed. You know, like lawyers need to know they aren’t aiding and abetting, which if you don’t know, is helping someone commit a crime.

As the Crown Prosecution Service put it:

“Although it is not possible to attempt to aid and abet, it is possible to charge the aiding and abetting of an attempt”.

Therefore, all conveyancing solicitors take the issue of mortgage fraud seriously. And it’s something all landlords should be aware of because it’s the why behind the how. It’s why there are so many rules to follow and how you seemingly have to jump through endless hoops to obtain finance.

Defining mortgage fraud

The simplest way to explain mortgage fraud is to think about insurance fraud since that’s something everyone is reasonably familiar with. You tell your insurance company accurate details to get the right quote. Falsifying data for a cheaper insurance policy is fraudulent. And it should be mentioned pointless too because falsifying data renders policies void. The same thing happens in the mortgage market.

People were, and some likely still are, using the get-out clause for every consumer being able to access interest-only mortgages, which up until 21st March 2016 is an unregulated financial product. Strict criteria don’t need to be met by lenders.

However, they aren’t completely off the hook if this happens, because arranging a buy to let mortgage for a consumer intending to live in a property without sufficient funding to repay it, could land any party involved in the transaction in muddy water.

Since repayments of residential mortgages are over a longer-term, some are tempted to approach the interest-only mortgage market. This isn’t fraudulent in itself, but pretending to have the income you don’t have and don’t intend to gain is.

On interest-only mortgage products, the capital isn’t paid back initially, and it is more suited to buy-to-let mortgages for business purposes. As such, some people who were finding it difficult to obtain a mortgage, perhaps due to limited income, would attempt to circumvent that by claiming the property would be rented so the revenue would increase.

The Mortgage Credit Directive

The Mortgage Credit Directive comes into force on the 21st of this month (21st March 2016).

It will be the primary legislation governing all types of mortgages, including consumer buy to let mortgages.

The Directive splits the buy to let mortgage into two categories. One is for consumers, where they perhaps inherit properties and subsequently lease out. That type of situation is regarded as accidental landlords.

The Landlords Guild comments “…Lenders have to impose affordability tests that are similar to residential mortgage underwriting”. This will make it more difficult for accidental landlords to access financing.

The other type is for the professional buy to let market. At the time of application, there will be a requirement to declare if you are applying for business purposes. The CBTL mortgage will be regulated as a financial product because consumers need protection, but for business purposes, consumer law won’t apply, therefore that segment of the buy to let market will remain partially unregulated since consumer protection won’t apply to business finance.

What this means for the property developer

Going by the statements from some leading UK lenders, there’s not going to be any material changes to the application process.

However, for mortgage brokers, there are some concerns. While 70% don’t see any significant changes, 17% expect to do less business in CBTL mortgages or houses in multiple occupancy financing, while 12% predict more business.

Property developers have always known the importance of financing. In particular, getting things in place before attending auction houses where properties can be snatched up cheap. Most properties which go to auction often require repairs, maintenance or value-adding upgrades. Mortgages of any type rarely offer much above the property valuation, if any.

For property developers, this often puts constraints on the upgrades that can be done to properties. Furthermore, for a home to be considered for any mortgage product, it has to be habitable. It’s often the case with auction properties that they aren’t habitable at the time of purchase, which is why they are snatched up on the cheap.

When considering any property, financing should be considered first, because without it in place, there’s a smaller chance you’ll be able to complete the project within the required budget.

That’s when you may want to consider a bridging loan because it won’t be tied to the property but instead be considered on its own merits. If you have a property and know what you’re going to do with it, it is possible to bridge the financial gap, and since it’s not directly tied to the Mortgage Credit Directive, there are far fewer restrictions on accessing finance with bridging.

Without getting too much into the political side of things, it’s worth pointing out that this new Directive coming into force is not the choice of the UK government. The Mortgage Credit Directive is European Rules.

As Louise Reynolds of Property Venture pointed out though – “George Osborne is making things worse for landlords” – this is in regards to the stamp duty increase as reported here. They are two separate issues currently affecting landlords.

There’s no denying the fact the buy to let market, and every landlord is going to see their business forego some changes and rapidly. Some will weather it out and thrive, while others may consider throwing in the towel, but regardless of how you feel, now is an excellent time to review your portfolio.

If you have your eye on a property or even a semi-commercial mortgage and want to invest before the tax changes come into effect in April, the fastest route to financing will be a bridging loan.