What finance factors drive buyer confidence?
Buyer confidence in Australia’s real estate market is riding high at the moment – the highest in more than a decade – but what’s behind this surge to the housing market and what finance factors are driving this extraordinary level of buyer confidence? And, crucially, is any of this overwhelming buyer confidence misplaced?
Buyer confidence growth
A record number of buyers are flocking to the housing market, anxious to acquire their own slice of Australia.
In fact, according to CoreLogic, almost 600,000 houses and units changed hands over the year to August 2021, which represents a jump of 42 per cent on the previous year. And by the end of August 2021, housing turnover, nationally, had risen to 5.6 per cent, the highest rate since December 2009.
And there is clear evidence that while house price growth may be slowing fractionally, buyer confidence in the housing markets around Australia, particularly in the capital cities, is continuing to roar ahead.
Factors at play
There are some key financial factors that contribute to buyer confidence and, in particular, fan the flames of property demand. When one of these factors is adjusted, it has a small impact, but when all factors are tweaked, buyer interest can be encouraged or cooled, depending on what action is taken. Here are few key financial elements that are influencing the real estate market.
Interest rates: At the time of writing, (November 2021) it had been more than a decade since Australians faced any increase in the cash rate. The last time Australians encountered a rate rise was in November 2010, when the RBA moved rates a quarter of a percentage point from 4.5 per cent to 4.75 per cent. 
Since then, it has been 11 years of consecutive rate cuts, to land at the current record low rate of 0.10 per cent. A low cash rate means that borrowing is cheap and will drive strong levels of loan applications.
The cash rate is one of the single-most-watched finance factors that drive buyer confidence. When the RBA wants to stimulate spending, the cash rate is the lever that’s pulled. A low cash rate gives buyers confidence to borrow, safe in the knowledge that repayments will be cheaper.
APRA guidelines/lending criteria: APRA is the financial regulator that sets out the lending guidelines for our banks. Debt-to-income ratios and buffer levels are key elements in any loan application and form a foundation against which lending criteria is applied. These two factors are crucial in driving buyer confidence.
Over the past two years we have seen some relaxed lending criteria that’s encouraged buyers to the market. However, as the floodgate of buyer interest has served to push up house prices significantly, we are beginning to see APRA and the RBA, under the supervision of the federal government, look at the tools in their utility belts to assess how best to slow the runaway freight train that is the Australian housing market. They are looking to these measures as a means to achieve this.
The debt-to-income ratio is a figure that summarises your financial position, taking into account income and debts. To calculate your own debt-to-income ratio simply add up all your debts and divide by household gross income. For example, say a couple that’s earning $80,000 each, and have credit card debt of $3,500, plus a personal loan of $5,000 want a mortgage of $400,000. Their debt-to-income ratio would be $408,500 (calculated thus: $3,500 + $5,000 + $400,000) divided by $160,000 = 2.5. This is considered a low debt-to-income ratio and would be viewed favourably by the bank. A debt-to-income ratio of 6 or more is considered high.
However, as house prices have risen significantly, debt to income ratios have been pushed higher and some banks have been lending to customers with a debt-to-income ratio of 8 or 9. APRA is monitoring this closely and has cautioned lending institutions (known as deposit-taking institutions) that they would prefer banks restricted lending to a maximum of 6 times debt to income. It seems likely that action on this front will be the next in line as regulatory bodies aim to slow house prices by cooling buyer interest.
Next there’s the buffer rate. The buffer rate is the interest rate (and the repayments) at which the loan applicant is assessed. APRA recently (October 2021) increased the buffer by 0.5 percentage points to 3.0 per cent. So, for example, if you are applying for $400,000 and the bank is offering a loan with an interest rate of 2.5 per cent, the application will be assessed as if you are making repayments based on 5.5 per cent. This is a tool to ensure serviceability in the event of a rate rise and at the moment, that event horizon seems to be in 2024.
When the buffer is low, buyers can have a greater confidence in being approved and when approvals are easier to come by, this drives confidence in the market. Now that APRA has increased the buffer this may serve the beginning of the cooling of buyer confidence.
Summary
The housing market has long been a key driver of economic recovery and growth.
Lending conditions have been set to drive buyer interest and stimulate the economy and there is no doubt these measures have been successful.
Buyer interest has pushed up house prices to record levels, but the fiscal framework is only one part of the puzzle. Property is an investment and as the price grows the question for buyers becomes one around value and return on investment. For example, will the high price paid for the investment be recovered at sale time (however many years down the track that sale might be)?
APRA and the federal government are monitoring house prices and buyer interest closely. It is likely we’ll start to see a cooling of activity, and, therefore, prices over 2022, as the question of value becomes even more pertinent.
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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.
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