As we discussed in last weeks article ‘Is the Financial Regulator about to tighten home lending rules?’, the banking regulators has indeed done, well, exactly that.
Commencing Nov 1st 2021, the Australian Prudential Regulation Authority (APRA) will increase the interest rate buffer on their mortgage serviceability tests for loan applicants from 2.5 to 3.0%.
What is the interest buffer?
The interest rate buffer is set by APRA to try and ensure that the mortgage holder would be able to withstand an interest rate increase and still be able to service their mortgage. The idea is to ensure that people do not overborrow and make themselves vulnerable to default should interest rates change. By increasing this rate, in effect reduces the amount that someone can borrow based on the serviceability of their weekly repayments.
The interest rate buffer does not affect the current base interest.
So how much will this affect the average loan applicant? APRA estimates that this increase would equate to about a 5% reduction in an applicant’s potential loan amount. So let’s say you had been eligible for a $550,000 mortgage with the previous buffer, soon the total loan amount available will reduce to $522,500, a reduction of $27,500! This means that a prospective buyer may either have to reduce their budget available or find an additional $27,500. Ouch.
How will this affect First Home Buyers?
Although first home buyers make up a smaller proportion of total home purchases nationally, they are also most likely to apply for and or require loans closer to their maximum allowance, meaning they will still be disproportionately affected by the new rules. Ultimately, it is difficult to argue that tightening loan conditions whilst house prices are rising helps home buyers, because in the short term it simply does not.
When will see any direct effects on the market?
As we mentioned in last week’s article, APRA is not trying to reduce or cool the housing market. Instead, its primary objective is to target the debt-to-income ratio of owner-occupiers and make people less vulnerable to shocks in the economy. At the end of the day, the regulator does not want homeowners defaulting on or overly struggling to pay mortgages. As house prices have far outpaced income rate growths, the amount of highly indebted owner-occupiers has been increasing.
Fewer loans mean less demand
In a normal world, when it is harder to get a loan, there should be a corresponding reduction in housing demand. However, we are unlikely to see the results of these new restrictions for many weeks or even months. Why? Because unless interest rates do rise (which seems unlikely this year) and with increased vaccination uptake across the country there is always the counter current of pressures that continue to increase demand.
Will there be more restrictions?
The short answer is, probably. One move that APRA is considering is directly limiting the high debt-to-income (DTI) ratio of loans such as is done in the UK and more recently New Zealand.
In the UK the ratio is set to 6, which means for someone with a salary of $100 000 (and assuming no other debt at all), they would be able to borrow $600,000. However, not everyone makes $100,000 and not every house or unit is $600,000. Quite the contrary.
The median house price in Brisbane is currently is $674,738.
In Brisbane, the median wage is just under $80,000 whilst the median house price is $674,738. However, with a DTI of 6, a person with this salary could only borrow $480,000. In Australia, lenders have been lending with DTI ratios from 7-9 in some cases, so do not be surprised if this will soon end.
Who will this second round of restrictions likely affect?
In Australia, you could see how this restriction would more directly affect a larger share of real estate investors, which is also another significant demographic that fuels the housing market. Whilst serviceability of mortgage repayments are affected by the APRA interest rate buffer, a DTI would impact investors more, who tend to leverage higher DTI ratios and are better able to service loans overall.
Ultimately, fewer people are able to get the loan amounts they want which should affect demand. However, as mentioned earlier, these restrictions will take a while to see, and could be minimised by prevailing pressures such as border openings, resuming international travel and economic recovery. Only time will tell.
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