Banking regulators have announced tougher usability tests on home loans that will make it difficult for some borrowers to get a mortgage. On the same day, New Zealand’s Reserve Bank begins raising its benchmark rate.
- Banks have to put a slightly tougher test of a borrower’s ability to afford mortgage repayments
- APRA is concerned about the number of buyers taking in more than six times their pre-tax income, and this move will limit that
- The value of residential real estate has increased by 20.3 percent in the past 12 months
In a letter to banks on Wednesday, the Australian Prudential Regulation Authority (APRA) raised the minimum interest rate buffer for home loan applications from 2.5 to 3 percentage points.
She estimates that the increase will reduce the “maximum borrowing capacity for the typical borrower by about 5 percent”.
It also says the move “will have no impact on mortgage rates”.
“All ADIs [authorised deposit taking institutions] should operate with a buffer of at least 3 percentage points above the lending rate, “warned the regulator in the letter.
“If ADIs continue to approve loans with a lower buffer rate after the end of October 2021, APRA will adjust the individual regulatory capital requirements to reflect the higher credit risk of new lending.”
What does it mean?
This means that from November banks will have to check whether new borrowers can still afford their mortgage payments when mortgage rates have risen to 3 percentage points above the current rate.
In other words, if you applied for a 2 percent mortgage on November 1st, the bank will check if you can afford a 5 percent repayment. If this is not possible, the loan application will be rejected.
If they fail to apply this higher test, they will be financially penalized by having to hold more reserves for losses, which would reduce their profitability.
In practice this means that all regulated institutions use the minimum buffer of 3 percentage points.
For home loan applicants, this means that the maximum amount people can borrow in relation to their income and expenses is lower than the old 2.5 percent usability test.
Interest rates rise abroad
The move to test borrowers with higher interest rates seems appropriate given the recent official rate hikes abroad.
The Reserve Bank of New Zealand is the last central bank to hike rates, raising its benchmark from a record low of 0.25 percent to 0.5 percent.
His move can be traced back to rising inflationary pressures and the state’s own property boom, which saw prices soar by around 30 percent last year, despite measures being taken to contain them earlier this year.
In its post-meeting statement, the RBNZ’s Monetary Policy Committee warned that “the level of house prices is currently unsustainable”.
“Members noted that a number of factors are likely to constrain house prices in the medium term. These include high housing construction rates, slower population growth, changes in tax regimes and stricter bank lending rules,” the statement said.
“Rising mortgage rates, if monetary policy incentives are reduced, would also push house prices to more sustainable levels.
Despite the ongoing COVID outbreak, New Zealand has now joined South Korea and Norway as the developed economies that have started moving interest rates away from pandemic lows.
Housing risks are increasing in Australia
Wayne Byres, chairman of APRA, said the move should reduce the construction risk of a growing number of very large mortgages.
“Although the banking system is well capitalized and overall lending standards have held up, the rise in the proportion of heavily indebted borrowers and the general indebtedness of the household sector mean heightened medium-term risks to financial stability,” he noted.
At least one of the big banks welcomed the move itself.
“We believe APRA’s announcement to raise the serviceability floor is a sensible and appropriate step to take some of the heat out of the housing market,” Commonwealth Bank CEO Matt Comyn said in a statement.
“After raising our floor to 5.25 percent in June, we believe this further move will add convenience to borrowers and be a prudent move for lenders.”
Adrian Kelly, president of the Real Estate Institute of Australia (REIA), said most borrowers do not borrow to their maximum capacity, so the changes should have only modest effects.
“REIA has always wanted responsible lending practices because the last thing we want to see in our industry is people biting off more than they can chew,” he said.
Further restrictions “may be necessary”
Many analysts had anticipated tightening home loan requirements following recent comments from regulators and the treasurer, but most hadn’t expected the change to happen anytime soon.
However, some say we can expect further tightening measures in the future.
“This is a modest change in the context of the current strength of the housing market,” said David Plank, head of ANZ’s Australian economics division.
APRA agrees that “the overall impact this will have on macroeconomic credit growth is expected to be quite modest”.
RBC’s Su-Lin Ong said APRA chose its current approach because it was a proven approach that was easier to implement than other alternatives, such as capping high-debt loans.
“Our reading of today’s APRA statement, coupled with our assessment of credit growth, particularly vis-à-vis key cohorts such as investors, suggests that further action is likely if the buffer rate hike does not dampen credit growth,” she warned.
The head of CBA agrees that more rules may be needed to reduce risks in the home loan market.
“We’ll be rolling out the changes this month and expect additional steps may need to be considered once the lockdowns end and consumer confidence rises,” added Mr. Comyn.
Rule change is likely to hit investors hardest
APRA said the rule change is necessary as there has been a significant increase in very large amounts of borrowing in recent months.
“In the June quarter of 2021, for example, more than 20 percent of new ADI loans went to borrowers who had taken out more than six times their pre-tax income.
“That is high both in historical and international comparisons, and without measures the proportion should continue to increase.”
The increase in the interest buffer applies to all new borrowers, but APRA said the impact of a higher maintenance buffer is likely to be greater for investors than for owner-occupiers.
This is because, on average, investors tend to borrow at a higher level of leverage and may have other existing debts (to which the buffer would also be applied).
It found that first-time home buyers tend to be underrepresented as the proportion of borrowers who borrow a large multiple of their income as they tend to be constrained by the size of their deposits.