Changes in the home loans landscape

This month the Australian Prudential Regulation Authority (APRA) announced that lenders need to increase their serviceability buffer from a minimum 2.5 per cent to at least 3.0 per cent, asking lenders to implement the changes from 1st November. 

 Through concern about the level of debt that borrowers are carrying relative to their income, APRA hopes changing the rules around how banks assess the serviceability of home loans will cool rising household debt levels. 

Earlier this month APRA was quoted in the media stating: “household debt levels relative to income are high, both historically and internationally, and the rate of household credit growth is likely to exceed income growth for the foreseeable future, further adding to debt levels.”  

I don’t think the announcement really came as any surprise given the talk in the media and general commentary around potential curbs for lending, surging house prices and the increasing disconnect with affordability for many Australians. 

What APRA has ruled on is loan serviceability and not the interest rate that borrowers receive.

Matthew Andrews, General Manager of RE/MAX Australia’s finance arm, Pivotal Financial, explains. 

“The rate that APRA is talking about is the serviceability buffer. For example, prior to the change, a borrower might receive a rate of 2.79 per cent, but the bank would add the serviceability buffer to that rate when assessing their borrowing capacity,” Mr Andrews said. 

“In this case, the lender would assess the loan application with a rate of 2.79 per cent (borrower rate) plus 2.5 per cent (serviceability buffer), adding up to a serviceability rate of 5.29 per cent.  

“Under the new terms, the serviceability rate is 2.79 per cent plus 3.0 per cent, so 5.79 per cent.” 

We know there has been much speculation as to how this ‘subtle approach’ to improving financial stability might impact borrowing demand. 

The reason that the property market is so hot is a supply and demand issue. This is a relatively mild intervention. Is half a percent going to stop the property market in its tracks? 

Mr Andrews suggests that borrowing power is reduced across the board by around five per cent and borrowers might expect to meet stricter lending criteria to secure funding. 

If a household’s maximum borrowing capacity was $1 million previously, it will now be $950,000. If it was $500,000, it will now be $475,000.  

A $400,000 home loan under the old rules could drop your borrowing power to $380,000. 

We know that the increase in the interest rate buffer applies to all new borrowers but how might it affect different buyer groups? 

First home buyers might find their deposit gets them less than it did before. They might have a harder time borrowing as much or satisfying the bank’s criteria to even get a home loan. 

While first home buyers tend to be more constrained by the size of their deposit, they can often borrow heavily to get into the market.  

One concern I have is that this tighter lending decreases 'accessibility' rather than promoting 'affordability'. 

There is more conversation around how it might affect investors, and there are several different schools of thought here. 

Investor loans normally have higher interest rates than owner-occupier homes (because APRA believes investors tend to borrow at higher levels of leverage than owner-occupiers and also have existing debt already, which may expose them to more risk).   

Because the rates are already higher, the new buffer will affect investors even more. 

Some commentators suggest that investors may not be as affected as owner occupiers because investors have access to equity, rental income and salaries as income streams to help their serviceability. 

The buffer increase affects new loans. The assessment will be harder, but what investors already have shouldn’t be affected – they shouldn’t be in any more difficulty because interest rates aren’t going up.  

However, refinancing generally involves new loans, so investors may feel effects from raised serviceability buffers.  

It might dampen the opportunities for some people who already have significant property portfolios and debt portfolios, with their ability to refinance likely to be reduced. 

CoreLogic head of research, Eliza Owen, suggests that investors may “bear the biggest burden”. 

APRA itself noted that investors “tend to be more leveraged in their borrowing behaviour and may be carrying additional housing debt, which would also be subject to the increased serviceability assessment.” 

The impact of a higher serviceability buffer is likely to be larger for investors than owner-occupiers. 

For the third month in a row, investment mortgage loan growth outpaced first home buyers, arguably driven, Mr Andrews said, by the loss of government incentives against rising house prices. 

“Encouragingly, a number of lenders appear to be turning on the tap for investors,” he said. 

 “We are seeing refinance rebate campaigns, sharper fixed rates and variable rates for investor loans as the banks turn their focus to where the action is. Investors are back in the market.” 

Investors and owner occupiers already in the market will be less affected because they can use the equity from their existing home to help fuel any subsequent home purchases. 

If you are an investor with good serviceability, you’ll be fine. The wealthier can keep buying.  

I agree with Mr Andrews that a reduction in borrowing capacity might take a bit of buyer competition out of the market by putting the brakes on over-extended borrowers but buyers making decisions well within their financial means won’t necessarily be negatively affected. 

The Australian economy is still recovering 

Certainty is a commodity at present. That’s why we are seeing so little stock on the property market. Days on market are historically low. 

This first play by APRA might just shift rather than cool markets and there’s a good chance we’ll see some markets have another run as prices normalise.  

Predictability of prices will encourage sellers whereas there’s been a reluctance to sell for fear of what they can buy.  

We may see fence-sitters in the more expensive markets be prompted to make their move into more affordable regions and interstate capitals. 

APRA intervened in the property market by tightening some of its rules around borrowing and loan serviceability.  

This move isn’t going to slow most of the markets, but it is setting off alarm bells about what more they might do to restrict levels of debt. 

This step may be the first of multiple, as it’s clear the regulator will consider the need to do more if new mortgage lending on high debt-to-income ratios remains at high levels. 

We think market strength will continue. It will be interesting to see what future regulatory changes are introduced, if any.  

Regardless, we have every confidence that property will remain a very good investment decision.