What has happened to financial services recently? Endowments vilified as shambolic, pension salespeople as commission-hungry leeches preying on the vulnerable and condemning clients to a Siberian retirement.
There is more to come on with-profits bonds, FSAVCs and income drawdown. People need money for retirement – is it time to consider an historic favourite again?
Residential property has always been an attractive retirement alternative to clients. With low interest and inflation rates, income investments are singularly unattractive so the proposition of investing in property becomes almost as solid as the buildings themselves. Yet the buy-to-let as an argument does not seem to be one that advisers exploit. Why should they if even the lenders are uncomfortable with them?
I recently delivered a talk to the Council of Mortgage lenders where 80 or so lenders from a variety of lending institutions were present. The talk explored the plethora of lending schemes now available in the buy-to-let market andI talked about some of thevery attractive offers now being generated from the 33 lenders active in this market, including a product with an initial rateof only 4.75 per cent.
Then I was asked: “Surely it is madness to lend money on a buy-to-let proposition where the initial cost of funds to the lender is greater than the rate being charged?”
Better rates are available to owner-occupiers, including a rate as low as 1.3 per cent. So why was the question asked? Is it because the perceived risk in lending in the buy-to-let market is much greater than traditional lending and so the rates should be much higher?
The response is a difficult one. The reason being that the individual posing the question (and I expect he has many supporters in the lending industry) considers the buy-to-let market to be more risky than the mainstream owner-occupier market. If a rate is offered that is so competitive then it must be flying in the face of common sense.
But is it? I would suggest that lending in the buy-to-let market can be safer in terms of risk than similar sums lent to owner-occupiers. This is a controversial view and I hope to persuade you my logic does stand up, so please read on.
Let us consider two average proposals, one in the buy-to-let market and the other froma first-time buyer intending to be an owner-occupier.
The lender considering an owner-occupier will lend up to 95 per cent for an individual who has been employed for only a matter of months and has no mortgage protection policy and has no guarantee of continued employment. The buyer will not need to demonstrate any ability to maintain the property and will not be required to prove his disposable income can make the repayments.
The applicant will havelittle or no credit history and no track record of repaying a mortgage. The competition from the 170 or so lenders dictates that the product will not deliver any early return to the lender and will be a real cost to the lender over the initial years of the advance, either through a cashback, a heavily discounted rate or a fixed rate at a level below the cost of funds. The valuer will undertake a cursory inspection of the property and confirm it is worth the price being paid at the time it is bought.
In contrast, a buy-to-let application is usually from somebody who has already established a track record in making payments to a mortgage lender. They will require a loan of up to 85 per cent of the value of the property and will have a review of their income and expenditure undertaken to ensure the payments to the mortgage can be maintained. They will need to have a minimum income of around £30,000 a year and demonstrate that if the tenant vacates the property that the payments may be kept up.
They will already have a mortgage elsewhere and will have established a track record of repayment. The valuer will be asked to ensure that the property can be sold in theopen market for the purchase price both now and in the foreseeable future in addition to being asked for evidence that the rent being charged is reasonable for the location.
The Mortgage2000 (ore-mortgage) sourcing system contains over 4,000 mortgage products from more than 170 lenders, including 182 buy-to-let products from 33 lenders.
If we were to compare the profitability of the two types of mortgage, we could take a loan of £70,000 over 25 years and calculate the lowest cost provider for an owner-occupier at 95 per cent loan to value. The interest cost over five years works out as £22,600. As a comparison, the similar best terms for a £70,000 buy-to-let loan(at 60 per cent of the value of the property) over 25 years would cost £24,900.
In other words, the lender has advanced a much lower percentage of the purchase price while earning an additional £2,300 over five years.
Interestingly, the Council of Mortgage Lenders recently issued a report that contained the following statistics on buy-to-let mortgages:
38,100 loans worth £2.8bn advanced in 1999.
80,000 loans worth £8bn advanced to date.
Only 0.4 per cent are three months in arrears.
When one considers these statistics against a backdrop of demographic trend projections from the DoEE which suggest that many more single-person homes will be required over the coming years as more people are divorcing, choosing to live alone, leaving home earlier or outliving their partner, then the risk of lending in this sector looks even less of a concern.
Are buy-to-let lenders mad? I don't think so. As deals become more competitive – and they will – and more lenders enter the market, opportunities for advisers become clearer. Pensions, with all their problems, remain the mainstay of retirement planning but buy to let will give clients further flexibility when retirement time comes.