The regulatory boundary is what makes this part of CF6 examinable. Two borrowers can take an almost identical loan on an almost identical property, and one is protected by the full mortgage rules while the other is not. Knowing which is which is worth several marks.
Regulated or not
| Type | Regulated? |
|---|---|
| Residential mortgage on the borrower own home | Yes, a regulated mortgage contract |
| Business buy to let, where the borrower deliberately invests in property to let | Generally not regulated |
| Consumer buy to let, where the borrower did not enter into it wholly for business purposes | Yes, subject to a separate consumer buy to let regime |
| Second charge on the borrower own home | Yes |
| Bridging on the borrower own home | Yes, subject to specific provisions |
| Buy to let bridging for business purposes | Generally not regulated |
The classic consumer buy to let example is an inherited property that the new owner decides to let rather than sell, or a let to buy where an owner lets their former home because they cannot sell it. A landlord with a portfolio and a stated intention to invest is a business borrower.
Even where lending is unregulated, most lenders apply comparable standards voluntarily, and an adviser still owes a duty of care and remains subject to their firm procedures.
The buy to let assessment
Buy to let affordability rests mainly on the rent rather than the borrower income, and the test is an interest coverage ratio.
The lender takes the expected market rent, confirmed by a valuer, and tests it against the mortgage interest at a stressed rate that is usually well above the product rate and subject to a floor. The rent must exceed that stressed interest by a set margin, commonly 125% for a basic rate taxpayer or a limited company and 145% for a higher rate taxpayer, because a higher rate landlord keeps less of the rent after tax.
Lenders also apply:
- A minimum income requirement, often around £25,000
- A maximum loan to value, typically 75% to 80%
- Minimum and maximum ages, and experience requirements for larger portfolios
- Portfolio landlord rules, where four or more mortgaged buy to let properties trigger an assessment of the whole portfolio and a business plan
Landlord taxation, in outline
CF6 does not ask for R03 depth, but it does expect awareness.
- Rental profit is taxed as property income, with expenses deducted
- Finance costs on residential lettings do not reduce taxable profit. Instead relief is given as a basic rate tax reduction, which pushes some landlords into higher rate tax on income they never keep
- The additional dwelling surcharge applies to stamp duty land tax on a second property
- Capital gains tax applies on disposal, with the annual exempt amount now £3,000
- Furnished holiday lettings and limited company structures are treated differently, which is why many portfolio landlords now buy through a company
The finance cost restriction is the point examiners return to, because it explains why the 145% coverage ratio exists.
Second charge lending
A second charge sits behind the first charge in priority and is secured on the same property, requiring the first lender consent where the mortgage deed demands it. Since second charge lending was brought within the mortgage regime, the same affordability, disclosure and advice standards apply.
A second charge is worth considering rather than a remortgage where:
- The existing first charge has a very low rate that would be lost
- An early repayment charge on the first charge outweighs the higher second charge rate
- The borrower circumstances have changed and a full remortgage would fail affordability
- Speed matters and the first charge cannot be varied quickly
The adviser must compare a further advance from the existing lender, a full remortgage, a second charge and an unsecured loan, then justify the choice on total cost and risk. Converting unsecured debt into debt secured on the home is a risk that must be spelled out.
Bridging finance
Bridging is short term, interest is often retained or rolled up, and the exit route is the key issue. A closed bridge has a contractually certain exit, for example an exchanged sale. An open bridge does not. Costs are high, and the adviser must be satisfied the exit is realistic. Regulated bridging on a borrower own home carries specific MCOB requirements, including that the term is normally twelve months or less.
Answering a case study
Start by classifying the loan, because the classification determines the rules that apply. Then apply the right affordability test, coverage ratio for buy to let or income and expenditure for regulated lending. Finish with the risks, and for landlords always mention void periods, maintenance, tenant arrears and the finance cost restriction.