As forecast last week by your truly, skyrocketing house prices in most markets are putting the financial regulators under pressure to take action – and this week they have.
The Australian Prudential Regulation Authority (APRA – the body in charge of managing the banks and other lending institutions) has announced a rule change that will mean those lenders must take a slightly more conservative approach when assessing mortgage applications. And this approach will impact the amount of money people can borrow to buy a property.
At the moment, when a bank is assessing your mortgage application, they look at your household income and scrutinise your expenses and your spending habits, and, applying the current interest rate, they assess how comfortably you can make your repayments.
As most Australians are aware, on the first Tuesday of every month the Reserve Bank of Australia meets to decide whether to put rates up or down, or to keep them on hold.
So, just in case rates start to rise, lenders will apply an interest rate tolerance buffer when assessing your mortgage application. They want to be sure that you can still comfortably make your mortgage repayments if the rates go up again (which is inevitable, it’s just a question of when and by how much).
To make sure you’re a safe bet, they test your repayment capacity at 2.5 percentage points higher than the rate you’re borrowing at.
So, for example, if you’re borrowing $300,000 at 2.35 per cent, they look at what the repayments would be if rates were 4.85 per cent, which is 2.5 percentage points higher than the actual rate you’re borrowing at.
This figure of 2.5 percentage points is called a serviceability buffer.
Under the new rules, APRA has said this serviceability buffer will now be 3.0 percentage points, which is 0.5 percentage points higher than before. To put it another way, banks will test whether you can meet your repayments at 3.0 percentage points above the interest rate you’re borrowing at rather than 2.5 percentage points.
So, let’s go back to our earlier example. If you’re borrowing $300,000 at 2.35 per cent, the bank will need to know if you can comfortably make your repayments to service your debt.
Under the old rules, the repayments on $300,000 at 4.85 per cent (excluding any fees) would be $398 per week.
Under the new rules, with a serviceability buffer of 3.0 percentage points above the loan rate, the repayments (excluding fees) would be $419 a week.
What’s the fallout?
On the face of it, a difference of $21 a week doesn’t sound like much and most people would shrug their shoulders and think they could trim $21 a week from their budget somewhere to accommodate this.
Even APRA said the impact would be “fairly modest”.
However, raising the serviceability buffer by 0.5 percentage points will most likely reduce the average customer’s borrowing capacity by about 5 per cent, according to research by Canstar. That would mean a customer’s borrowing capacity that was previously $500,000 would fall to $475,000.
It is hoped that this reduced borrowing capacity may force customers to buy a cheaper property and thus slow the meteoric rise of property prices.
The real impact is likely to be felt by investors. When an investor borrows to buy a property, they tend to be borrowing more with less. In other words, they tend to borrow with smaller (sometimes zero) deposits, using another property as collateral against the loan.
Investors have rental income along with their own personal income (to varying degrees, depending on how much of their own income is tied up in their principal place of residence mortgage) at their disposal to service the debt and banks will take this into account when deciding to lend to an investor.
Typically, also, investors borrow at greater than six times their debt-to-income ratio (read last week’s blog post here to learn more about the debt-to-income ratio and how it might affect your decision to buy a home) while first home buyers are constrained to smaller amounts by their lower income and smaller deposits.
What does it mean for you?
If you’re a first home buyer considering your first mortgage, these rule changes will likely have little impact, and that’s how APRA (and the federal Treasurer) wants it. As discussed in last week’s blog, governments are focused on getting first home buyers into their own home and so any regulatory measures introduced by APRA would generally take this into account and be designed to have as little impact on FHBs as possible.
As reported in The Age this week, “There has been speculation APRA would introduce home loan curbs for months, but regulators have also been keen to avoid making it even harder for first home buyers to enter the property market”.
And the good news is that this measure will slow down house price growth, which means you will have a better chance of getting your first home sooner if you’re keen to enter the market.
If you’re an FHB, continue saving your deposit, continue doing your research and, if you have questions, don’t hesitate to get in touch with an expert for advice.
Intuitive Finance – the smart choice
The world of banking and finance can be a pretty daunting one for both novice and sophisticated investors and since our establishment in 2002 we’ve focused on providing outstanding service and business standards.
This approach was vindicated when we were named Victoria’s Best Finance Broker at the 2017 Better Business Awards.
So if you’re considering investing in, or developing, property, why not contact Intuitive Finance’s Brisbane home loan experts or mortgage brokers in Sydney today to ensure you have the right information and expert support on your side no matter what stage of the property ownership journey you are on.
The information provided in this article is general in nature and does not constitute personal financial advice. The information has been prepared without taking into account your personal objectives, financial situation or needs. Before acting on any information you should consider the appropriateness of the information with regard to your objectives, financial situation and needs.