During this week, the Australian Prudential Regulation Authority (APRA) has decided to further tighten serviceability tests for home loans. The minimum interest rate buffer on home loan applications will increase from 2.5 to 3 percentage points.
What is serviceability buffer?
When considering mortgage applications, banks are required to examine borrowers' affordability at a higher interest rate than the actual interest rate offered so that borrowers will not be stressed when interest rates increase in the future. The serviceability buffer, or the buffer, is the additional interest rate added to the market interest rate during the examination process.
How it may impact borrowers?
Before considering its impact, one also needs to understand the serviceability floor rate. This interest rate is also used in serviceability tests. During serviceability tests, banks are required to assess applicants based on the higher of the floor rate or the actual rate plus the buffer.
For example, if a bank has a floor rate of 5.25 percent and an actual rate of 2.5 percent, then before this change, customers will be tested at a rate of 5.25 percent, as the floor rate is higher than the actual rate plus the buffer, 5 percent in total. However, after the increase in buffer rate, customers will be tested at a rate of 5.5 percent, the actual rate plus the new buffer, 3 percent.
It has been estimated that the increase will reduce "maximum borrowing capacity for the typical borrower by around 5 percent”. APRA also suggested that the move "will not have any impact on mortgage interest rates". Overall, this change will make it harder for borrowers to get large mortgages.
What may happen in the future?
APRA chairman Wayne Byres said the move was intended to head off building risks from a growing number of very large mortgages. Although many analysts did not expect a move in tightening home loan rules to happen so quickly, we can expect to see more tightening measures in the future. Commonwealth Bank chief executive Matt Comyn also suggested that "we will implement the changes this month and expect that it may be necessary to consider additional steps as lockdowns end and consumer confidence increases."
Policies that may be introduced
Two potential moves are lifting the floor rate and introducing a debt-to-income (DTI) ratio cap.
Since the current market interest rate is relatively low and banks use the higher of the floor rate or the actual rate plus the buffer for serviceability assessments, it is sensible to expect that banks will lift their floor rates to, say, 6 percent, in addition to the new buffer rate, to further reduce borrowing capacity.
Another possible movement is introducing a debt-to-income ratio cap, limiting the number of new loans with a debt-to-income ratio of six times or more which is the ratio that APRA considers as risky. As the ratio of risky new loans in the June quarter has increased from 16.0% in 2020 to 21.9% in 2021, APRA could limit lending on high debt-to-income ratios to address the increasing risk in Australia’s home lending market. However, such policy may also create barriers for first home buyers, and banks may lend more loans closer to the limit, resulting in a higher ratio of loans with a risky debt-to-income ratio.
Therefore, any new policy response needs to be thoroughly considered, especially since the buffer has just been announced to increase and the property market will be further impacted by the ease of restriction and the reopening of borders. However, it is almost certain that home loan applications will be further restricted in the future, especially for investors. So if you are thinking of buying a property, it is better for you to act fast since ease of restrictions will further stimulate the property market.
How we can help?
As home loan rules are tightening, in order to better support both local buyers and international investors, KBRZ has recently introduced a special home loan product, K-Loan with a more flexible approval process. A maximum loan amount of 1.5 million is available with interest rates starting from 2.37% for local borrowers and 4.78% for international customers, both supporting offset accounts.
