How to deal with rising interest rates

Transcription

1 A landlord s guide to: How to deal with rising interest rates

2 A landlord s guide to how to deal with rising interest rates As the UK s leading landlord association, we have a duty to support you in all aspects of your letting business, not least when it comes to keeping on top of your costs. Most landlords will use a buy to let mortgage at some point during their lettings career, which is why understanding interest rates, how they are set and the impact that they can have on your repayments is so important. Rising interest rates can pose a substantial risk to your profitability and in some cases the viability of your letting business. Whether you manage a small number of properties or a large portfolio, if you are reliant on mortgage finance, rate changes can have a big impact on your financial situation. But if you are prepared and plan ahead, you can anticipate risks, off-set the impact of future changes and hopefully soften the blow. Adopting the best practice we outline in this guide will not shelter you from the effects of interest rises, but it will mean that you and your business are well prepared. 2 A landlord s guide to how to deal with rising interest rates

3 Background to interest rates Interest rates have been at an historical low since March 2009 as the Bank of England s Monetary Policy Committee has held its base rate at 0.5% in order to aid economic recovery. When Mark Carney took up his position as Governor of the Bank he stipulated that interest rates would not rise until the UK unemployment rate had fallen to 7%. Despite some encouraging signs of economic growth, inflation is still weak, wage growth is slow and continued problems in the Eurozone have influenced the Bank s decision to await further improvements before increasing rates. Mark Carney has previously stated that interest rate rises, when they come, will be small and introduced in gradual increments. He has also hinted recently that rates could rise to between 2.5% and 3% by Speculation aside, any rise in interest rates will impact the buy to let sector, particularly the cost of buy to let mortgages and landlords would be well advised to make some contingency plans for this eventuality. What effects can rising interest rates have on you? Most buy to let mortgages have a product interest rate which is based on the Bank of England base rate. Normally this will take the form of a variable or tracker rate which is tied to the base rate by means of a differential. i.e. a tracker mortgage may be sold with a product rate of base rate plus 3 per cent meaning that the rate a customer will pay will always be 3 per cent above the Bank of England rate rising and falling accordingly. Therefore, with interest rate rises almost inevitable over the next few years, landlords with mortgaged property will take a hit on the profitability of their lettings. Example 1: A landlord client has purchased a property for 160,000 with a buy to let mortgage at 70% loan-to-value and expects to receive 650 per month in rent. The client has chosen a 2 year tracker product at Bank of England Base Rate (BBR) +2.89% with a 995 arrangement fee added to the loan. The current monthly mortgage payment is 319 per month. If we assume that Bank of England Base Rate rises gradually to 2.5% over the next two years, the landlord would end up paying a rate of 5.39% resulting in a monthly payment of 508. That s almost 200 more each month for just one property. If you then factor in any void periods, management fees and maintenance costs this scenario could result in them running at a loss. Landlords who have recently purchased additional properties with mortgages, particularly at higher loan-to-values, will have greater exposure to increases in their monthly financial commitments. A landlord s guide to how to deal with rising interest rates 3

4 Clearly, a rise in interest rates is of considerable concern to landlords and it could have a significant impact in a number of ways: Higher mortgage payments Landlords with tracker, or variable mortgages will face higher interest payments. Consequently this will cause a reduction in surplus cash flow from rental properties and, in a worst-case scenario, result in an operating loss. Can you afford to pay higher rates on your mortgage? Affordability Lenders assess the ability of a landlord to repay buy to let mortgages when they evaluate applications for finance. Higher interest rates mean higher repayments which may squeeze a landlord s margin and make them a higher risk for lenders. In some cases this could result in mortgage applications for the purchase of new properties or the remortgage of existing properties to be declined. Even landlords with existing borrowing can find their ability to repay loans affected by interest rate rises. Unplanned for financial burdens can cause increased levels of stress for those struggling to meet their commitments. Therefore it would be prudent for landlords to budget carefully in anticipation of increasing monthly payments for their own peace of mind. However, there is no need for landlords to panic just yet, as lenders usually include a buffer in their rent stress tests. This ensures that the current rental income being received would continue to be greater than the increased interest payment resulting from the small rises to Bank Base Rate that are expected in 2015/2016. Repossession Although relatively rare in relation to buy to let mortgages, in the worst case scenario, landlords who do fall behind in their mortgage payments may feel the threat of repossession and should always speak to the lender at the earliest opportunity if they are in difficulty. 4 A landlord s guide to how to deal with rising interest rates

5 What can you do to prepare for rising interest rates? Switching Products If you are not tied to a particular mortgage product, consider looking around for a better deal. Interest rates are currently low meaning that there are still deals to be found. You may even be able to obtain a fixed rate product to provide some shelter from immediate increases. However, there are many factors to consider when selecting a mortgage product and professional advice can be extremely helpful. With a dedicated buy to let team researching the mortgage market, NLA Mortgages can offer exclusive deals that are not available directly from lenders. As well as this there is a unique rental calculator to find products that fit your expected rental income. Pay down the mortgage Although not necessarily an immediate cost saving, especially as interest payments are tax deductible, reducing the value of your mortgage will reduce exposure to increases in interest rates. Simply put, the smaller the mortgage the smaller the impact of a percentage increase and the lower your risk. Of course this is very much dependent on your income and plans for repayment. Raising rent An obvious solution to the problem of increased mortgage payments is to raise rents. However, rents are an inelastic cost, meaning that there is only so much flexibility in a household s ability to pay. It will not always be possible, or advisable, to increase rents at the same time or pace as interest rates and many landlords will already have fixed agreements in place with their tenants. It is important to consider achievable rents when taking out mortgage finance and to plan for the increase in overheads throughout a tenancy. If you are worried that your current rents will not cover future interest rate increases it is wise to study the local market to see what increases may be possible, but remember not to price yourself out of good tenants. An empty property could be even more costly. Savings Probably the most important safeguard is to have a standalone savings plan running alongside buy to let property investments, specifically for unforeseen costs. There are other potential problems that may arise besides increased mortgage payments, such as burst pipes, broken boilers and rental voids, which a prudent landlord should be prepared for. By putting savings aside, specifically for maintenance of your property and/or unexpected bills and payments, you can reduce the risk that rising interest rates will threaten your finances. Disposal of property Although hardly the ideal way to plan for increased costs, you should always be realistic. If a particular property is relatively highly geared and consistently underperforms, you may wish to consider selling before any increases kick in. Markets are currently fairly buoyant in much of the UK and you may find that other investments offer a lower risk profile. A landlord s guide to how to deal with rising interest rates 5

6 Budgeting As well as having a solid savings plan, landlords should also take the time to plan their budgets in advance to make allowances for interest rate rises. It is much better to be prepared for increased mortgage payments beforehand and will help reduce the level of stress experienced when it happens. Landlords looking to purchase or remortgage in the next 6 months may wish to consider choosing a fixed rate mortgage. NLA Mortgages most popular buy to let mortgages are often 2 year fixed rates, however, with imminent rate rises likely it may also make sense to also look at longer term fixed rates. There has certainly been a growing demand for 5 year fixed rates and NLA Mortgages currently has over 100 such products available from over 10 different lenders, so there is a fairly wide choice. Example 2: A landlord client has purchased a property for 160,000 with a buy to let mortgage at 70% loan-to-value and expects to receive 650 per month in rent. The client has chosen a 4.39% 5 year fixed rate with a 1,995 arrangement fee added to the loan. The current monthly mortgage payment is 417 per month. If we assume that BBR rises gradually to 2.5% over the next two years, the landlord in this example will continue to pay 417 per month for the mortgage. The initial monthly mortgage payment in this example is almost 100 more expensive than in the previous example. However, if Bank of England Base Rate stabilises at between 2.5% and 3% in 2017, choosing a 5 year fixed rate now could deliver substantial savings over the longer term. Not only could a longer term fixed rate provide financial benefits, it also provides security and peace of mind while interest rates start to rise as landlords are able to budget around a predictable fixed monthly payment. NLA Mortgages NLA Mortgages is a free online buy to let mortgage sourcing system enabling landlords to search and compare products from the full market offering. You can select the best mortgage for you. NLA members also benefit from cash back upon completion. With a dedicated buy to let team researching the mortgage market, NLA Mortgages can offer exclusive deals that are not available directly from lenders. As well as this there is a unique rental calculator to find products that fit your expected rental income. NLA Mortgages experienced support team has an in-depth knowledge of the buy to let mortgage products available in the market and the current lending criteria. To find out more about NLA Mortgages, or to sign up to the service, visit 6 A landlord s guide to how to deal with rising interest rates

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