High Net Worth Mortgages
As an asset class, property has outperformed equities and fixed income over decades. Charlotte Richards finds out what the options are for clients who want to use direct property as a source of income.
Over the past few years, property prices have been booming. They have even increased faster than the pace of earnings. According to recent data from LSL Property Services, residential property prices are now increasing at twice the pace of earnings, up 5.5 per cent annually compared to 2.1 per cent salary growth.
Property is an asset class that has seen relatively solid returns for investors, and is seen as a somewhat safe investment. There are varying ways to access the market. The easiest and cheapest route is through either an open-ended fund or a real estate investment trust (Reit). Another way is going direct, using a mortgage to do so. The space is growing in demand, specifically as a part of retirement planning.
Recent research from peer-to-peer lending platform, Crowdstacker shows that 44 per cent of retail investors want to enhance their exposure to the UK property market beyond owning their home. The survey, carried out among 2,049 non-retired adults, shows the biggest factor driving this investor demand is the long-term growth of the UK property market (62 per cent), followed by strong levels of rental income (59 per cent).
One area that was predicted to boom after last April’s retirement freedoms as a way of retirees receiving an income was buy-to-let. But has this boom transpired?
Bob Young, chief executive at lender Fleet Mortgages, believes there has not been as big an uptake in buy-to-let as many originally predicted. He says, “You don’t typically look to make income out of buy-to-let. It’s more about growth over time.” He explains that the buy-to-let market is split into two areas: the spectators, people who think they can do it to return a quick profit; and semi-professional investors, who invest for a long time with a view to it forming part of their planning.
“Buy-to-let is a part of my personal retirement plan. I don’t typically look to make an income out of it, but it is more about growth. In my own portfolio, initially I was making virtually no yield on it, but 15 years later, I have a low loan-to-value and a good income, which will form a portion of my income when I retire,” he says. Semi-professional investors, he explains are people with one or two properties although typically not earning enough from them to make a proper income out of it.
But Mr Young says that, regardless of whether or not you can make a solid income, Fleet’s brokers are getting enquiries from people who want to invest in a buy-to-let property for income. “We are cautious about those types of borrower because typically, buy-to-let is like any asset class. You can get really good returns if you do the hard work.”
He explains many people do not understand it is more difficult than just buying a property anywhere and getting good returns.
“We had a couple who were living in Southampton, but wanted to buy around Liverpool. It was a sign that they did not understand the asset they were buying. Managing a property in Liverpool when you live on the south coast is very difficult. We declined them as a loan. You need to give it a bit more thought,” he adds.
“If you look at it logically, the average pension pot is £30,000. If you take out 25 per cent of that, you are not going to be able to buy much of a property. But if you took someone with a pension pot of £300,000 then the 25 per cent is £75,000, so as a deposit this is not a bad start. This type of person with bigger pension pot is someone who is more investment-minded. We do not see a huge amount of those.”
Elsewhere in the buy-to-let market, the Mortgage Credit Directive (MCD) comes into force on 21 March this year (more on page 12), and will impact regulation of first and second charge mortgages, as well as consumer buy-to-let activity. From 1 April, there will also be changes to stamp duty for buy-to-let investors and those buying second homes. Chancellor George Osborne announced in his Autumn Statement and Spending Review in December that stamp duty will be raised by 3 percentage points, as shown in Table 1.
When it comes to the MCD, Mr Young does not think the buy-to-let market will be greatly affected. He believes the MCD plus the changes to stamp duty on second properties and buy-to-let may deter speculative borrowers. “That is a good thing,” he says.
Another route to own property is through the use of borrowing within a pension scheme. Both small self-administered schemes (SSASs) and self-invested personal pensions (Sipps) allow borrowing when investing in commercial property. Both are popular choices for investors wanting to gain access.
It must be noted that these are strictly for commercial property exposure, which can also provide solid returns for income. The test of what classifies a property as commercial rather than residential, is that if the property can be lived in then it is residential – although oddly, HM Revenue and Customs classify beach huts as residential.
There are some exceptions to the commercial and residential rules. Recently, Claire Trott, director and head of pensions technical at Sipp and SSAS provider Talbot and Muir, was contacted by someone wanting to buy a pet shop, but the property’s contract stated that the manager of the shop would have to live in the flat above it to look after the animals at night.
This can be an exception in allowing someone to live in part of the building because it is part of the job contract – so long as the person who lives upstairs is not a scheme member, relative or anyone connected to the scheme. She adds this is more common when buying pubs and the manager lives in the property.
Investors wishing to use their pension pot to buy property can borrow up to 50 per cent of the value of the pension, and it has no bearing of the value of the property.
Martin Jarvis, associate consultant at Mattioli Woods, explains that there is no difference in borrowing within a Sipp or a SSAS, as they can both borrow the same amount of scheme net assets. “They can also borrow from a connected party as long as further conditions are met – mainly the transaction is carried out on a ‘commercial’ basis and no special terms are granted because of the connection,” he says.
Ms Trott says, “It is only tested at the point of time when you take the loan out. If your other assets drop in value, it does not mean you have gone over your borrowing limit.”
Group Sipps are structured in the same way, so 50 per cent loan against each name. Ms Trott says, “It can be easier if you are buying as a group to buy through a SSAS rather than a Sipp. The costs can be less and paperwork too. If there are three or more people and they are eligible to have a SSAS, then that route is recommended.
“A SSAS loanback is a good thing. If a company wants to borrow money from its pension scheme, then it can work really well at a very low cost rate – less than 2 per cent,” she adds.
The use of borrowing within a pension scheme is “perfectly fine,” Ms Trott adds, saying it is something she sees a lot of although typically, “Pension funds aren’t big enough to buy the whole property.”
Mr Jarvis says if all conditions are met, pension scheme borrowing can provide an extension of the purchasing power of pension funds. “The flexibility of being able to borrow from connected parties means that borrowings can help wider scheme planning dovetail with business planning – for example, securing extra funding for the scheme to purchase commercial property from the business,” he adds.
The mortgage crash of 2008 may be many years behind us, but it is understandable if it is still fresh in many investors’ minds. It should be kept in mind that, since then, more regulation and tighter rules on lending have come into force with the Mortgage Market Review (MMR). But whether it is commercial or residential, buying property is no longer as difficult as it once was. Although, if simplicity is what a client wants, then a property fund or investment trust may be the best – and cheapest – option.
Specially for you
Specialist lending has been reinvented, but seems to have found its niche. Jon Cudby reports
The economic landscape of the UK has undergone a significant shift in recent years, largely prompted by the crash.
It should be no surprise that the area most commonly identified as causing the 2007 and 2008 crash – specialist lending – has also seen some of the biggest changes, reinventing itself to recover.
It is probably true that the issues that caused the crash were not so much to do with the lending model, but the fact that the wrong people were using it. The typically sub-prime, self certification deals that came to characterise the specialist lending sector were dubbed “liar loans” in a pejorative reference to the perceived credibility of those taking them out.
However accurate that monicker, self-certification has all but disappeared from the UK mortgage marketplace, beaten down by a reputational battering following the crash, and then finished off by a tightening of requirements from both the regulators and the lenders themselves. In reality though, the sector has suffered from a conflation of several separate terms in the public psyche.
Self-cert, specialist and sub-prime lending are not synonymous, but are frequently used interchangeably. It is the last of these that is commonly held to have caused the crash, but even then, that was only sub-prime lending activity in the US. As such, there are many who feel that the reaction in this country has been extreme.
The limited borrowing opportunities for those who managed to secure a sub-prime loan in the days when they were more easily accessible, mean in reality a lot of those with old sub-prime loans have been unable to move on to any new deal. At best they may have found a new deal with their existing lender, but, so long as their status limits them to sub-prime borrowing, their choice will be limited by the hugely contracted market. These ‘stuck’ individuals will still account for a large proportion of the current sub-prime borrowers.
While the demise of sub-prime and self-cert has tarnished the perception of specialist lending, the sector has enjoyed a reinvention that has seen parts of it flourish. After all, much of this government’s policy is designed to foster entrepreneurial spirit within the UK. This would not be encouraged by making it harder for the self-employed to borrow money.
Alan Cleary, managing director of specialist lender Precise Mortgages, recognises an evolution to meet the growing demographic. He says, “You’ve got a fundamentally different asset class; there is no comparison between specialist lending that we’ve got today and talking about what was being done in 2005 or 2006.”
Traditional high street mortgage lenders appear to have no desire to appeal to the self-employed either, Mr Cleary argues, “High street banks have focused since 2008 on people with big deposits who are completely vanilla. The behaviour should be that a broker tries Halifax and Santander first because they are cheaper, but if they fail their credit score, they should give us a try.”
There is a perception that the self-employed are getting a bad deal. Employed loan applicants typically just need to show a P60 and three months of wageslips. The self-employed will need to show audited accounts, with lenders often choosing to use an average of previous three years’ earnings or even the lowest year.
Alan Lakey, a partner at Highclere Financial Services, says lenders should be more willing to embrace the self-employed. “There has to be a facility for a borrower to say ‘there is no risk to us.’ If they lend 50 per cent of property value and then end up getting repossession, they are not going to lose on the deal, so why wouldn’t they want to do that?” He says the imbalance is made worse by lenders’ inability or unwillingness to overrule computer systems.
According to Mr Cleary, specialist borrowers do not in reality represent any more of a risk. “Self-employed people have less predictable income, but they also have excess income; if they need to earn more money, they can work more hours. An employed person doesn’t have that option. For [Precise], self-employed actually performs better than P60.”
Specialist lending is enjoying a revival, but still too many hurdles are in the way for the borrowers who need it. The self-employed have been a key factor in job creation since the crash. It only makes sense that they are not penalised through being effectively barred from home ownership.
The Advent of the Foreign Currency Mortgage
On the 21st of March this year the European Mortgage Credit Directive (MCD) comes into effect and its primary objective is to harmonise the regulation of mortgage lending across EU member states, including the United Kingdom.
Although lenders and brokers have been aware of these new regulations for some time, most homeowners will be blissfully unaware of the potential impact the changes to mortgage lending resulting from the MCD may have on their ability to borrow in the future.
One change that has generated some confusion is the requirements that relate to foreign currency loans. There is a possible assumption by some that the change only impacts those borrowers funding property overseas using loans provided in a currency other than GBP pounds sterling.
However, this is not the case.
At its most basic, MCD introduces a new definition of a foreign currency loan to the UK market. It considers a foreign currency loan to be:
• a mortgage in a different currency to that which a borrower receives income;
• a mortgage where the borrower is using an asset held in a different currency to fund any part of the loan; or
• a mortgage in a different currency to the European Economic Area (EEA) in which the borrower is a resident.
Some typical borrower scenarios that are managed under this new definition include:
• if they receive an element of their income (salary or bonus) in a currency other than GBP pounds sterling and said
income is required to repay any part of the mortgage; or
• if they use any assets held in a currency other than GBP pounds sterling to repay any part of their mortgage; or
• if they are not a resident in the UK and want to purchase a property in the UK.
Take the following example of a typical borrower who is living and working in the City and buying property in central London. They receive their annual basic salary in GBP pounds sterling and their annual performance bonus in euros
as they work for an international business. If the bonus is used to repay any part of the mortgage, then the loan is classified as a foreign currency mortgage under the new regulations.
If the same borrower described in the example uses any assets (not just salary or bonus – it could be shares or property, for example) that are in a currency other than GBP pounds sterling, then again the loan is classified under MCD as a foreign currency mortgage.
So why is this a big deal? A significant number of lenders have said they won’t offer foreign currency mortgages after the introduction of the MCD in March. The reason they give is because the number of foreign currency mortgages they deal with is so small it isn’t cost-effective to change their systems and procedures to accommodate the new MCD regulations – such as disclosing to borrowers fluctuations in exchange rates of more than 20%, for example.
However, the good news is that there are a number of UK lenders, such as Investec Private Banking, that will continue to offer foreign currency mortgages post MCD, so don’t think that this is a sector of the market that will effectively
wither and die.
On the contrary, it may well be a sector that grows and flourishes, because foreign currency mortgages will be relevant to a wide range of borrowers. If you have clients who you think may be affected by the new regulations, it’s worth pending a bit of time identifying which lenders will be able to offer them a loan after the introduction of the MCD in late March.
It’s also worth bearing in mind that the type of borrowers who will be affected by the new foreign currency mortgage rules may well be higher income earners with more complex financial circumstances, which can add another level of complexity to sourcing a mortgage on their behalf.
The following hypothetical case study highlights some of the challenges which may arise when arranging a foreign
currency mortgage after the implementation of the MCD.
Do bear in mind, however, that foreign currency will be just one element of the loan application that a lender takes
into consideration and only one of the changes resulting from the MCD. The overall size of the loan required, amount of income generated from vesting shares and frequency of bonus payments may also, for example, be important considerations when determining whether a lender will provide a mortgage offer or not. It is therefore important that brokers not only understand which lenders will be able to provide foreign currency mortgages post MCD, but also which of those lenders will be able to help borrowers with specific requirements, such as large loan amounts.
The following case study is a hypothetical example of the type of application that would be classified as a foreign currency mortgage under the new MCD regulations, to be implemented on the 21st March this year.
Simon is a senior banking executive working in London. Born and bred in Yorkshire, Simon moved to London when
studying at university and, on graduating, he set out on a career in financial services. Over the past 15 years Simon
has moved rapidly up the management ladder within the same European bank. He is based in the bank’s London office and is now responsible for the bank’s asset finance and leasing activities in the UK and across Europe.
Simon receives a combined salary and annual bonus worth £750,000 and has a home in central London worth £2 million and a portfolio of other investment property worth £1.5 million. Simon’s children are about to move to senior school next year and he and his wife have decided that the time is right to move out of central London to a more rural location which offers the right combination of lifestyle, easy access to Simon’s office and, importantly, access to good schools. Simon and his wife have found the perfect family home and want to borrow £1.2 million on a property valued at just under £3 million. He has spoken to his mortgage adviser, who has immediately flagged up a number of challenges:
• An important part of Simon’s income is his annual bonus which, because he works for a European bank, is paid in
euros rather than GBP pounds sterling. Simon receives his monthly salary in GBP pounds sterling, but his bonus
payments, which will be required to repay the mortgage, mean that his loan application will be classified as a foreign
currency mortgage under the new MCD regulations.
• Although the mortgage required is only 40% of the value of the property being financed, the £1.2 million being borrowed puts the application beyond the reach of a number of lenders.
His broker has therefore recommended a specialist lender that is comfortable with larger loans and familiar with the financial issues facing higher income earners.
Although his high level of income, bonus and assets make Simon initially appear to be an attractive
proposition for any lender, the reality is that he would find getting a mortgage more challenging than he anticipated, after the introduction of the MCD.
There are a number of specialist lenders, including Investec Private Banking, that would consider such an application, but there is no question that placing such an application will become more challenging for brokers in the future.
This article is prepared for intermediary use and is for general information only. It is important that your client understands that their home or property may be repossessed if they do not keep up repayments on their mortgage.