Australians will be able to get a bigger mortgage if Australia’s prudential regulator goes ahead with a plan to loosen requirements for banks to use a minimum 7 per cent interest rate when assessing borrowers’ ability to service loans.
The Australian Prudential Regulation Authority (APRA) has flagged lowering the minimum interest rate serviceability buffer from 7 per cent to a level determined by banks and other lenders.
The removal of the interest rate floor comes amid falling house prices, record-low credit growth, and expectations that the Reserve Bank will cut interest rates this year. The cash rate is currently at an all-time low of 1.5 per cent.
For the past four-and-a-half years, APRA has required banks to test prospective borrowers against the higher of either an interest rate of 7 per cent, or a 2 per cent “buffer” over the loan’s actual interest rate, to ensure they could meet repayments if rates rise.
The regulator also asked banks to ensure borrowers were “comfortably” above these thresholds, which has meant most banks test whether customers can manage repayments if interest rates hit 7.25 per cent, which is much higher than the actual mortgage rates, currently sitting below 4 per cent for many owner-occupier borrowers.
However, APRA chairman Wayne Byres said with interest rates at record lows, and likely to remain at historically low levels for some time, the gap between the 7 per cent floor and actual rates paid “has become quite wide in some cases — possibly unnecessarily so.
“In addition, the introduction of differential pricing in recent years — with a substantial gap emerging between interest rates for owner-occupiers with principal-and-interest loans on the one hand, and investors with interest-only loans on the other — has meant that the merits of a single floor rate across all products have been substantially reduced.”
The proposed changes, while likely to increase the maximum borrowing capacity for a given borrower, “are not intended to signify any lessening in the importance that APRA places on the maintenance of sound lending standards,” Mr Byres added.
“Rather, it is simply recognition that the current interest rate environment does not warrant a uniform mandated interest rate floor of 7 per cent across all products.”
APRA says proposed change gives ‘flexibility’
In a letter to authorised deposit-taking institutions (ADIs) issued on Tuesday, APRA said ADIs could be permitted to review and set their own minimum interest rate floor.
However, ADIs would need to apply a mandatory interest rate buffer of 2.5 per cent.
Mr Byres said the operating environment for ADIs had evolved since the current serviceability assessment was introduced in December 2014, prompting APRA to review the “appropriateness” of the current guidance.
APRA has also faced lobbying on this issue from Australia’s major banks, which all saw their share prices increases more than 1 per cent in morning trade on the prospect of a change, following much bigger gains yesterday on the surprise return of the Morrison Government.
Mr Byres said the proposed changes will provide ADIs with “greater flexibility to set their own serviceability floors, while still maintaining a measure of prudence through the application of an appropriate buffer to reflect the inherent uncertainty in credit assessments”.
A four-week consultation will close on June 18, ahead of APRA releasing a final version of its updated guidance that will need to be followed by banks.
Change could see more Aussies get a mortgage
Market experts say the change could increase peoples borrowing capacity and thereby see more people take out a mortgage.
Cameron Kusher from CoreLogic said the proposed APRA changes “seem sensible given the interest rate environment with the expectation that rates will fall from here and remain lower for longer.
“Furthermore, since 2014 it has become much more difficult to get a mortgage, which is partly because of this serviceability assessment,” he said.
He said the proposed changes were welcome and, if implemented, “will help some borrowers that can’t quite access a mortgage currently to get one”.
While it will remain much tougher than in the past to get a mortgage because of other areas of tightening, he said “overall, for the housing market it will mean more people are able to get a mortgage.
“These proposed changes in conjunction with the uncertainty of the election now behind will potentially provide additional positives for the housing market.”
Furthermore, he said the changes may also ease some of the urgency for official interest rate cuts by the Reserve Bank.
“If housing can provide some additional economic stimulus, rate cuts may be less necessary,” Mr Kusher added.
Although it appears that the Reserve Bank is almost certain to cut interest rates next month, following a speech by the RBA governor Philip Lowe today.
CoreLogic currently expects the property market to bottom in mid-2020 but is not forecasting a rapid rebound.
“Despite that prospect, it will remain more difficult to obtain a mortgage than it has done in the past and we would expect that if/when the market bottoms a rapid re-inflation of dwelling values is unlikely,” Mr Kusher said.
Move will ‘increase borrowing capacity’ and ‘leverage’
ANZ economist David Plank said the move relates to a material easing in the credit constraint facing households.
In its recent update to the market, ANZ estimated that household borrowing capacity has been reduced by about 30 per cent because of various steps taken by the regulator over a number of years, and due to last year’s focus on the use of HEM (the Household Expenditure Measure).
“ANZ estimates that the servicing rate floor was responsible for almost a third of this reduction,” he said.
“The use of a floor won’t disappear, but it seems reasonable to think it will come down some way from the current 7.25 per cent used by the major banks, certainly to something with a 6-handle on it. This is an effective easing in policy settings, in our view.”
Frank Mirenzi, senior credit officer, financial institutions groups at Moody’s Investors Service said removing the minimum 7 per cent interest rate floor that banks use in their assessment of mortgage serviceability will help support credit growth and could stem the fall in house prices.
“The proposal will likely increase borrowing capacity and potentially allow households to increase leverage,” he said.
“However, banks have progressively tightened mortgage underwriting practices over a number of years, which mitigates the risks of a resurgence in excessive credit growth and another house price boom.”
In the question and answer session at a lunchtime speech in Brisbane, Reserve Bank governor Philip Lowe said he did not think APRA’s move was incompatible with responsible lending.
“It is up to the bank to implement that responsibly, isn’t it?” Dr Lowe responded.
“I don’t see it as being inconsistent, but the banks still need to make their decisions and pay due regard to the responsible lending laws.”
Dr Lowe also downplayed the effect the changes might have on lifting borrowing and boosting home prices.
“The data we have says between 10 and 15 per cent of people borrow the maximum the bank will allow them but, if APRA does remove the floor, some will borrow more and some will take advantage of that and that will help,” he observed.
“But that is not a substitute for lower interest rates, because they work through the exchange rate and affect the cash flow of every person who has a borrowing at the moment.”
This article by Nassim Khadem was originally published on abc.net.au. Click here to read the original article