The Dark Side Of Buy-To-Let

For the first time since records began, a greater proportion of landlords are in arrears than mainstream borrowers.

Last week's mortgage arrears and repossessions figures showed that both have risen over the last quarter. And given restricted financing options combined with falling house prices, it's not surprising. 

But what is surprising is that for the first time since records began, buy-to-let arrears are higher than mainstream arrears, according to the Council of Mortgage Lenders (CML).

At the end of September, 1.58% of buy-to-let loans were in arrears (up from 1.10% at the end of June), compared with 1.44% of all mortgages. The number of buy-to-let mortgages taken into possession was still lower than in the mainstream market at 0.08% of all buy-to-let mortgages (compared with 0.1% across the mortgage market as a whole). But based on the arrears figures, it's probable that buy-to-let repossessions will overtake the mainstream market before long.

Why the payment problems?

The CML says that the payment profile of buy-to-let lending worsened more rapidly than the market as a whole because of falling rents and an oversupply of rental property in some areas. This resulted in some landlords being unable to let their property or achieve high enough rents to support their borrowing commitments.

It has also become more difficult to sell a property in order to exit the buy-to-let market, while the availability of new buy-to-let mortgage finance has contracted and criteria have tightened.

Before 2008, buy-to-let mortgage arrears were extremely low, and certainly below the mainstream level. Only five years ago, for example, just 0.33% of buy-to-let landlords were three months in arrears.

But the last five years have seen lenders become more and more generous, until it became possible to get a buy-to-let loan with a small deposit  of just 10% (and sometimes less), and minimum rental cover of 100% of payments. (Traditionally, lenders had required rental income to cover 125% of mortgage payments to provide a necessary buffer zone.)

This generous lending criteria afforded little protection or leeway to landlords when things started to go wrong, particularly the lack of rental cover needed. A couple of months' void, tenants unable to pay, or a huge maintenance bill have been enough to stretch some landlords' finances to breaking point.

Tight times

Now the pendulum has swung right back with lending criteria -- lenders require a deposit of 25% and minimum rental cover of 125% - just like the old days. This makes it nigh on impossible for many new buy-to-let landlords to enter the market (and some would argue that's a good thing).

But it also impacts on those unfortunate landlords who want to renew their deal. They may find that the sums simply don't stack up in the current cautious lending environment, and their only choice is to languish on standard variable rate (SVR) until more deals become available.

After all, if you borrowed at 90% loan-to-value (LTV) two years ago, chances are your property price has not risen by enough to bring your LTV down to the 75% required to remortgage. In fact, you may even be heading towards negative equity.

Equally, if your rental income stacked up at 110% of mortgage repayments, it probably doesn't now qualify you for a mortgage that requires 125% rental cover. Until more deals become available you will have to stay on the lender's SVR.

But for those with sufficient equity and adequate rental income, there are still some buy-to-let deals out there -- but they are not cheap.

For example, one of the best rates available is The Mortgage Works' 4.69% two-year fixed rate, available through brokers only, up to 70% loan to value. But it comes with a whopping 3.5% arrangement fee. Yes, that is £7,000 on a £200,000 mortgage.

The cheapest fee I could find on a buy-to-let deal is the Post Office's three-year fixed rate mortgage at 6.74% up to 75% LTV with a tiny £599 fee.

If you want a tracker rate, there are not many around, but C&G has a four-year deal at 5.89% (Base Rate plus 2.89%), available up to 60% LTV, with a 2.5% fee.

Rents down

If things weren't bad enough for landlords, the Royal Institution of Chartered Surveyors has just recorded the first fall in rents for five years.

It blames the fall on increased supply on the market, as would-be homesellers decide to let out their property until house prices recover. (Read more about this report here.),

The National Landlords Association (NLA) has gone so far as to say that this new breed of `reluctant landlords' poses a major risk to the overall health of the British rental market. It says that this glut of new landlords let out their own properties to avoid selling at a loss - and so enter the market hoping it will only be for the short-term.

The NLA warns `reluctant landlords' that they need  permission from their mortgage lender, building insurer and, if necessary, freeholder, to let out their property as well as making sure they comply with the gas and fire safety, energy performance certificate and tenancy deposit requirements. (Read How To Rent Out Your Home for more on this topic.)

Compare buy-to-let mortgages at Fool.co.uk