Why is the British government cracking down on Buy-to-Let landlords?

At the start of this century a lot of middle class Brits got into the landlord business, buying houses to let out to people who rent. Some of them were looking for an income yield, but most were happy if the rent would cover the mortgage, and they'd end up with a fully paid house 20 years down the line, which they could sell to fund a pension.

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Starting in 2014, the govt started tightening the criteria applied to them. Buy-to-let landlords used to be able to offset the interest paid on the mortgage at their marginal rate of tax - so basically if they were a 40% taxpayer, they could offset at 40%. This is being changed to a flat 20% in stages over the next four years. Landlords used to be able to claim a flat 10% against wear and tear, but now they can only claim for actual repairs they have done, and they have to submit receipts. In 2015 the govt announced that people who own more than one house (i.e. landlords) have to pay an extra 3% stamp duty when purchasing any futher property.

And the blows keep on coming - this year they introduced "section 24" which says that when a landlord refinances a house, the lender must do a full income and expenditure assessment based on the current rent the property is receiving, and check they could cope with interest rate rises. Because of the other changes to the way the property is taxed, landlords with high loans to value will struggle to refinance.

Landlords are spitting tacks.

Why is the government taking this action?

It is to do with risk. The government is determined to avoid a property crash, as historically govts with a crash on their watch don't get re-elected.

There are two ways the property market can crash. The first is caused by a recession: people lose their jobs, they can't keep up their repayments (there are no non-recourse mortgages in the UK, so you can't walk away from debt) and put their homes on the market. If too many people do this at once, prices start falling, especially if the seller is distressed and has to sell.

The other way a crash can happen is if interest rates rise, people on variable or tracker mortgages would see their mortgage payments rise and people on fixed rate deals would have to refinance at a higher rate once their two-year deal ended. If money is tight for the borrower, they may not be able to afford the new payments and have to do a distressed sale. Too many distressed sales at once usually causes a property crash.

The borrowers at most risk are the Buy-to-Let Landlords

Owner occupiers are in a good situation. Those who were on variable rate mortages before the 2008 financial crunch saw their payments cut dramatically as interest rates were cut. Many used that spare money to overpay their mortgages to clear their debts faster. As a result, in 2014, for the first time households who owned their homes outright, free and clear of a mortgage, were the biggest group.

Those who have taken out new mortgages since 2008 have been subject to affordability tests to make sure they could cope with interest rate rises. In any case they have been steadily paying down their mortgages, so with each month, they get into a stronger position.

However this is not the case for landlords, due to the way they finance their properties. They will typically buy a property for say £100,000 with a 10% deposit. When the property price rises to £120,000, they remortgage at a 90% loan-to-value. This allows them to "extract" £18,000 in cash from the property. They then buy property number 2, for £100,000, putting down a 10% deposit and using the other £8000 for refurbishment. Rinse and repeat, till they have a slew of houses.

The problem with this approach is that the loan-to-value remains high. Debt isn't being repaid. A small change in interest rates might mean that the rents they get arn't covering the mortgage. A similar problem arises if the renter is delinquent and behind on their payments. Because landlords typically own at least 15 properties each, with some owning as many as 160, a distressed landlord would result in hundreds of houses being dumped on the market, sparking a crash.

The new rules are forcing landlords to deleverage. If they can't refinance, they can't extract money to buy their next property, which reduces competition and allows first-time buyers to purchase instead (and as they are subject to affordability tests, these new first time buyers reduce the risk in the system). Landlords who now find the new rules make the business unprofitable are selling their properties.

The government clearly feels that it is better to force the weak landlords to sell now, while the economy is still strong and interest rates are low.

The Bank of England monitors loans-to-value, and when they deem them low enough across the board, they'll feel safe about normalising interest rates.

If you have a mortgage (owner-occupier or landlord), I'd advise you to pay down as much of your loan as you can now - plans are clearly being laid to raise interest rates in the near future.