The banking regulator has announced tighter viability tests for home loans, which will make it more difficult for some borrowers to obtain a mortgage, the same day the Reserve Bank of New Zealand begins to raise its rate of benchmark interest.
- Banks will have to apply a slightly stricter test on a borrower’s ability to afford mortgage payments
- APRA is concerned about the number of home buyers who borrow more than six times their pre-tax income and this move will limit
- Residential real estate values have jumped 20.3% in the past 12 months
In a letter to banks on Wednesday, the Australian Prudential Regulation Authority (APRA) increased the minimum interest rate cushion on home loan applications by 2.5 to 3 percentage points.
He estimates that the increase will reduce “the maximum borrowing capacity for the typical borrower by about 5 percent.”
He also indicates that the move “will have no impact on mortgage interest rates.”
“All ADI [authorised deposit taking institutions] should operate with a margin of at least 3 percentage points on the loan interest rate, “the regulator warned in the letter.
“When ADIs continue to approve loans using a lower buffer rate beyond the end of October 2021, APRA will adjust individual prudential capital requirements to reflect the higher credit risk inherent in new loans. “
What does it mean?
This means that starting in November, banks will have to test whether new borrowers can still pay their mortgage payments if mortgage interest rates rise 3 percentage points above their current rate.
In other words, if you applied for a mortgage with a 2% interest rate on November 1, the bank would check to see if you can afford to repay with a 5% interest rate. If you couldn’t, the loan application would be refused.
If they do not use this higher test, they will be financially penalized by having to hold more reserves against losses, which would reduce their profitability.
In practice, this means that all regulated institutions will use the minimum 3 percentage point buffer.
For home loan seekers, this means that the maximum amount people can borrow relative to their income and expenses will be lower than under the old 2.5% utility test.
Rising interest rates abroad
The decision to test borrowers at higher interest rates seems timely given recent increases in official interest rates abroad.
The Reserve Bank of New Zealand is the latest central bank to hike rates, taking its benchmark index from a record high of 0.25% to 0.5%.
The move follows rising inflationary pressures and the country’s housing boom, which has seen prices rise by around 30% in the past year, despite steps taken earlier this year to contain them.
In its post-meeting statement, the RBNZ Monetary Policy Committee warned that “the level of house prices is currently unsustainable”.
Members noted that a number of factors are expected to constrain house prices over the medium term. These include a high rate of house construction, slower population growth, changes in fiscal parameters. and stricter bank lending rules, “the statement continued.
“Rising mortgage interest rates, as monetary stimulus is reduced, would also limit house prices to a more sustainable level.
Despite its ongoing COVID outbreak, New Zealand has now joined South Korea and Norway as developed economies that have started to move interest rates away from pandemic lows.
Real estate risks are on the rise in Australia
APRA President Wayne Byres said the move was aimed at avoiding the risks of building a growing number of very large mortgages.
“While the banking system is well capitalized and lending standards have generally been maintained, the increase in the share of heavily indebted borrowers and indebtedness in the household sector in general means that medium-term risks for the financial stability is accumulating, ”he noted.
At least one of the big banks has welcomed the move itself.
“We believe APRA’s announcement to increase the service floor is a sensible and appropriate step to help alleviate some of the heat in the housing market,” Commonwealth Bank Managing Director Matt said. Comyn, in a press release.
“After raising our floor to 5.25% in June, we believe this new step will provide additional comfort for borrowers and is a prudent step for lenders.”
Adrian Kelly, president of the Real Estate Institute of Australia (REIA), said most borrowers are not taking loans to their maximum capacity, so the changes should have a modest effect.
“REIA has always wanted responsible lending practices because the last thing we want to see in our industry is people who bite more than they can chew,” he said.
Other restrictions “may be necessary”
Many analysts expected tighter mortgage requirements after recent comments from regulators and the treasurer, but most did not expect the change to happen so quickly.
However, some say we can expect to see more tightening action in the future.
“In the context of the current strength in the housing market, this is a modest change,” said David Plank, head of Australian economics at ANZ.
APRA agrees that “the overall impact on overall housing credit growth that results from it should be quite modest.”
RBC’s Su-Lin Ong said APRA took its current approach because it was a proven approach and easier to implement than other alternatives, such as a limit on loans with a high debt-to-income ratio.
“Our reading of today’s APRA statement, coupled with our assessment of credit growth, particularly for key cohorts such as investors, suggests that further measures are likely if the increase in the rate cushion fails to moderate credit growth, ”she warned.
The ABC boss agrees that additional rules may be needed to reduce risk in the mortgage market.
“We will be implementing the changes this month and expect there will be a need to consider additional measures as the lockdowns end and consumer confidence increases,” Mr. Comyn added.
Rule change likely to affect investors the most
APRA said the rule change was necessary because there had been a significant increase in the number of people borrowing very large amounts in recent months.
“In the June 2021 quarter, for example, over 20% of new ADI loans went to borrowers who had borrowed more than six times their pre-tax income.
“This is high by historical and international standards, and without action, the share is likely to increase further. “
The increase in the interest rate cushion applies to all new borrowers, but APRA said the impact of a higher service cushion would likely be greater for investors than for homeowners.
He said this is because, on average, investors tend to borrow at higher debt levels and may have other existing debt (to which the cushion would also be applied).
He noted that first-time homebuyers tend to be under-represented as a share of borrowers borrowing a high multiple of their income, as they tend to be more limited by the amount of their deposit.