Buy to let mortgages in the UK are almost certain to be impacted by the European Crisis. Many are calling it the beginning of a lost decade or suggesting that it will tear apart the very fabric of the single currency. Some even see a Greek exit from the Euro as an absolute certainty. We’ll examine the impact of this crisis on UK lenders and our buy to let market.
The Interlinked Global Markets
The first time there was a credit slowdown it was due to the collapse of investment banking in the USA. Banks were uncertain as to the risks other banks had taken and their respective levels of exposure to bad debt. As a result of this they started to stop lending to each other to protect themselves from bad debt. This had a knock on effect – banks were unable to raise finance to continue to lend and some like Northern Rock were brought down by the inability to fund their operations and sought government assistance.
It’s not just the banks lending to each other that is impacted when they start to worry about each other. Most bonds and debt can be insured in case the borrowing institution goes bust. This ‘default insurance’ protects big investors from losing too much if a big player goes under. Of course many of these contracts were written in times when it was believed that banks were largely unlikely to default so insurers were highly exposed when a large number of banks around the world collapsed.
This situation has now moved to the next level where the governments who bailed out the failing banks to prevent a collapse of the system have themselves had to take on too much debt to do so. This debt is becoming increasingly difficult to service as many of the countries had other inefficiencies (such as poor tax collection) to go along with their high levels of debt, struggling economies and failing banks.
In a similar way to bank debt before the last crisis, many banks hold government bonds. Many of these banks are now significantly concerned about how exposed other banks they might usually lend to are to this potentially bad debt. As a result they are starting to cut back on lending to each other. Much in the same way as default insurance for bank debt was written in a time when it was unforeseen that banks would fail in big numbers much of this sovereign debt is insured by holders and on terms written when the collapse of several major European governments would have been absolutely unexpected. So once again both banks and insurers face potentially massive losses – just this time there might be nobody big enough to bail them out.
The Impact So Far – Banks Still Lending In The UK
With the recent good news that Paragon had initiated the first ‘specialist buy to let’ backed mortgage securitisation one would be forgiven for being optimistic about the current state of the financial market. Banks are still lending – in fact competition is at an extremely high level in the buy to let mortgage market at present and the ability of one of the more niche players to raise mainstream funding to continue to lend is a strong sign.
However as the stock markets around the world lurch up and down in chunks of 5% on every whisper of news from Europe it’s clear that the issues here are potentially greater than we’ve yet see feed through into the lending market. Most investors are working on the assumption that a political solution can be found but as governments around Europe are brought down and the people start to resist the austerity measures required to stave off default it becomes increasingly likely (as in the case of Greece) that an orderly default is the only solution. This feeds through into big losses for the banks and is likely to be complicated further big losses throughout the financial system caused by the complex insurance products and derivatives we have already discussed.
Strategy For Landlords To Consider
At the moment all the signs for the rental market are strong – rental yields have been growing in most parts of the country and demand has been strong enough to keep rental voids at record lows. On top of that many landlords are experiencing very low borrowing costs fuelled by the aggressive competition on buy to let rates and the wider economic uncertainty leading to the Bank of England keeping the base rate on hold.
As we’ve seen before, however, when many landlords saw their portfolios decimated by price falls in the North of England the situation can evolve very quickly when panic strikes at the heart of the financial system. If you analyse your portfolio in the face of a 2% higher base rate and lending margins worse than they are today (possibly leading to an overall 2.5-3% rise in your borrowing costs) it’s likely that your currently comfortably profitable portfolio becomes a weight around your neck instead.
The warning signs are there at the moment as for a couple of months now the spread between rates offered by lenders and base rate has started to increase again. This is a sign of banks finding it more difficult to fund their lending and their unwillingness to enter into contracts with each other for fear of exposing themselves to banks carrying exposure to European Debt.
Landlords carrying a portfolio which is relatively highly geared (70% loan to value or more) and where an assessment of their rental income compared to their mortgage payment is barely above 125% should be concerned about developments as we run into this crisis head on. Many landlords in this position will be on a short term product (often with under two years remaining at present) and only just meet current lending criteria for obtaining a new product when their current deal finishes. Many more landlords will have chosen to stay on a variable rate waiting to see what develops before deciding to fix or take another short term product.
The window of opportunity for many of these landlords could close very quickly if the situation in Europe continues to worsen. A small increase in borrowing costs combined with a tightening of lending criteria caused by a reduction in supply of funds to lend would combine to leave many landlords unable to refinance or take a buy to let remortgage on their portfolio. This could force them to relieve themselves of parts of their portfolio or simply face years of monthly losses until the conditions in the market improve. The last crunch also saw significant job losses throughout the developed World and this is likely to be repeated should more major European economies fail and naturally this will leave some rental properties void further exacerbating the situation.
Now Might Be The Time To Act
Facing these many challenges and a future of uncertainty now might be the time for many landlords to act. If your portfolio is vulnerable to the slightest change in lending costs, rates or lender criteria now might be the time to consider fixing in your payments and protecting yourself. It’s important you run the calculations at 125% and consider your mortgage at 2.5% or more higher than it currently is when you consider your exposure to risk over the next 5 years. Many landlords who feel very comfortable now will rue the fact they didn’t protect themselves against rate rises and an inability to obtain a new rate because they felt they were profitable at present.
Want to discuss your portfolio now with an expert adviser? Need to know more about the opportunity to take a longer term fixed rate on your buy to let remortgage? make an online enquiry now.