What impact will new European law have on the buy-to-let market?

At the moment buy-to-let lending is not regulated. But new rules from 21 March 2016 mean that around one in ten of this type of mortgage lending will come under the regulatory control of the Financial Conduct Authority. What does that mean for borrowers thinking of investing in property? Michelle Niziol, director at Independent Mortgage Solutions, explains

The snappily named Mortgage Credit Directive (MCD) is European legislation designed to bring mortgage lending in line across member states to create a single mortgage market; and increase protection for first and second charge lending* to consumers.

The UK government has taken advantage of an exemption in the MCD that allows member states not to apply the directive to buy-to-let activity if they have an appropriate framework for regulating it. The MCD will therefore be implemented through rules set by the Financial Conduct Authority (FCA) and will be law from 21 March 2016 but will not be applied to ‘business buy-to-let’.

The legislation does not give the FCA the power to change or modify the European standards, but to register, supervise and take action against any firm engaged in ‘consumer buy-to-let’ from March 2016.

Two types of buy-to-let

So what’s the difference between ‘consumer buy-to-let’ and ‘business buy-to-let’?

The MCD is effectively introducing a new concept of the ‘consumer buy-to-let mortgage’. This is a contract that is ‘not entered into by the borrower wholly or predominantly for the purposes of a business’.

Some examples of business buy-to-let and consumer buy-to-let

• Customers purchasing property with the sole intention of letting it would be a business application, as would applications from customers with other buy-to-let properties.
• If a remortgage application was made for an inherited property which the applicant had been living in since the inheritance but now wanted to let, this would be a consumer buy-to-let. But if they had not lived in the property since the inheritance the application would be treated as a business buy-to-let.
• If a remortgage application was for a property that has previously been lived in by the applicant but is now let out – known as a let-to-buy property – and it is their only let property this would be treated as a consumer buy-to-let application.

The FCA aims to give lenders flexibility in interpreting the legislative requirements so they can decide whether a customer is a consumer or is acting as a business, on a case-by-case basis. Customers looking to take a business buy-to-let may be asked to complete a declaration stating they understand the buy-to-let mortgage is for a business purpose.

Impact on UK lenders

The main changes to mortgage lending resulting from the MCD are:

1. Some buy-to-let mortgage lenders will become regulated by the FCA.
2. The Key Facts Illustration (KFI) is a document that summarises all the important features of the mortgage you are interested in and enables you to compare it with other mortgages. This will be replaced with the European Standard Information Sheet (ESIS) – a Europe-wide standardised set of disclosure information for customers.
3. Requirements relating to foreign currency loans will change.
4. Lenders’ processes, procedures and documentation will need to be reviewed and changed to ensure they align with the proposed changes.
5. Some buy-to-let lenders and brokers will have to register with the FCA to apply for and hold the relevant new FCA consumer buy-to-let permissions.
6. All second charge lenders and brokers must be registered with the FCA.

From a conveyancing perspective:

1. The MCD introduces a reflection period of at least seven days beginning when the lender issues its binding offer of loan; to give the customer time to make comparisons and assess the implications of taking out a mortgage.
2. During this reflection period the offer must remain binding by the lender.

Impact on consumers

There will be a few changes for consumers when applying for mortgages, both residential and consumer buy-to-let, including:

1. Consumers should be better informed due to the new MCD processes and the ESIS and better protected by the FCA.
2. Consumer buy-to-let landlords will be subject to affordability checks similar to residential mortgage applications.
3. Mortgage holders will have the right to repay a mortgage early, either partially or in full.
4. MCD won’t allow lenders to waive affordability checks under any circumstances.

The UK Mortgage Market Review (introduced in April 2014) was designed to fit within the MCD and includes an affordability check, to ensure mortgages are affordable at their current rate and at future rates. This means that lenders must also calculate whether a borrower can afford the mortgage if the interest rate increases by 3%. This has led to cases where remortgaging or switching to better mortgage deals are being refused, even though the monthly repayment is less than the borrower is currently paying.

However, at the moment lenders have a right to waive affordability criteria on remortgages where there’s no additional borrowing or they are the current lender. But there are concerns that the MCD won’t allow lenders to waive affordability checks under any circumstances.

In summary

The MCD has had a big effect on the UK mortgage market through the Mortgage Market Review of 2014. The next wave of legislation for consumer buy-to-let will have a more obvious impact on lenders, brokers and firms that deal with this area of lending. There will be new processes and procedures and possible fees, which may be passed on to consumers.

Buy-to-let mortgages account for a significant part of the UK mortgage market and the new consumer buy-to-let application process may mean smaller landlords will no longer meet the eligibility criteria when they come to remortgage. But overall, educating and protecting consumers against ill-advised lending is a positive change.

The majority of the buy-to-let market will be termed as ‘business’ and remain largely unaffected.