Buy to let investors face may face more financial woes as regulators try to stem the billions on interest only borrowing by landlords.

The Prudential Regulation Authority with encouragement from the Chancellor George Osborne and the Bank of England, is suggesting that buy to let mortgage lenders should all follow the same underwriting rules.

The measure would make sure lenders apply tougher stress tests to landlord borrowing to reduce the risk of defaults should interest rates rise.

The government and regulators are concerned that rules written when buy to let was only 2% of the mortgage market more than a decade ago no longer apply now landlords account for 15% of all mortgage lending.

To start the consultation, the PRA is suggesting;

  • All buy to let lenders should introduce a standard affordability test
  • The test should include a rent cover assessment based on a minimum interest rate of 5.5%, but preferably a rate of 2% over the current buy to let base rate
  • Affordability should include any tax the borrower will pay
  • If the rent does not cover the mortgage, affordability should be based on the borrower’s personal income net of tax, national insurance, spending commitments and living costs

Although loan-to-value (LTV) borrowing restrictions are not suggested, the regulator argues lenders should control their lending and avoid offering landlords loans at more than 75% LTV.

The PRA also wants to tighten up the definition of a commercial or portfolio landlord to that of a property with more than four homes to rent.

The paper says: “The proposals on affordability testing aim to improve the safety and soundness of PRA regulated firms by ensuring that they take full account of any potential interest rate rises in their buy-to-let underwriting assessment.

“This will help curtail inappropriately risky and imprudent lending – loans that are affordable under the current low interest rates environment but will quickly become unaffordable if and when interest rates rise – and lower potential credit losses and repossession costs.

“As a result, these proposals are also expected to help insulate the lenders, the financial sector and wider economy from the impact of negative shocks in the housing market.”