5 things you need to know about the APRA’s new lending rules
In October, the Australian Prudential Regulation Authority (APRA) announced it would increase the minimum interest rate buffer that it expects banks to use when assessing home loan applications.
This buffer, also known as a ‘serviceability buffer’, is designed to counter risks in home lending and ensure that borrowers would still be able to service their loan even if interest rates rise. In line with the latest changes, the buffer will rise to 3% above the loan product rate — a 0.5 percentage point increase compared to the current 2.5% that most lenders use.
So how will these changes affect you? In this post, we look at five things you need to know about the APRA’s new service buffer, and what it means for current and future borrowers.
1. It will affect maximum borrowing capacity
Lenders calculate a person’s borrowing power based on their ability to service their loan. This serviceability is affected by factors such as income, spending habits, existing household debt, and more.
Previously, if you wanted to take out a home loan with a 2.3% interest rate, lenders would actually calculate your maximum loan size based on that interest rate plus the 2.5% serviceability buffer — meaning they would determine your borrowing power based on an interest rate of 4.8%. Some lenders may adopt a minimum assessment interest rate (e.g. 5.50%) that may be more aligned to their risk appetite.
Taking that example above but factoring in the APRA’s latest changes, your borrowing power would then be calculated based on an interest rate of 5.3%.
Here’s an example showing how this would affect maximum borrowing capacity with a loan term of 30 years, based on a couple with no debts, a household income of $10,000 per month, and living expenses of $25,000 annually:
|Borrowing power based on 4.8% interest rate||Borrowing power based on 5.3% interest rate|
|Maximum borrowing capacity||$1,106,000||$1,053,000|
|$ change in maximum borrowing capacity||$53,000|
|% change in maximum borrowing capacity||-4.8%|
This echoes findings by PropTrack, which revealed that borrowers would experience roughly a 5% decrease in maximum borrowing capacity:
Bear in mind that this change will only affect borrowers seeking to borrow the maximum amount possible on their home loan. Many borrowers tend to borrow just below their maximum, which means that they’ll likely be at their maximum borrowing capacity after these changes.
2. Lenders will need to set their own ‘floor’ interest rate
In addition to the interest rate buffer set by APRA, banks also have their own ‘floor’ interest rate. These varying ‘floor’ rates are set by individual lenders and used to assess whether a borrower can service a loan.
In this round of changes, the APRA chose not to increase the interest rate floor that lenders use. This means that banks and other financial institutions can either assess whether borrowers can meet their repayments based on the minimum serviceability buffer of 3 percentage points or on their own floor rate, depending on which is higher.
For context, most banks have had a floor rate of roughly 5% for the past few years, while interest rates for fixed-term loans have been as low as 1.59% for a one-year term and 2.47% for a five-year term. This means the increased serviceability buffer of 3 percentage points would only affect borrowers with an interest rate that’s roughly above 2% to 2.5%.
“Given some borrowers are already constrained by the floor rates that lenders use, and that many borrowers do not borrow at their maximum capacity, the overall impact on aggregate housing credit growth flowing from this is expected to be fairly modest.” – APRA
3. Investors are more likely to feel the brunt of the changes
Although the interest rates affect all new borrowers from the end of October, most experts believe that investors will be the most heavily impacted by the APRA’s new rules — not owner-occupiers.
This is because investor loans and interest-only loans have a higher interest rate than the typical principal and interest loans that owner-occupiers would use.
4. This move will help stabilise Australia’s financial system
The APRA has lifted the serviceability buffer in response to Australia’s current lending climate. With low interest rates and rising house prices, the growth in household credit is expected to exceed the growth in household income in the future — causing massive pressures to borrowers across the country.
What’s more, this uptick in housing credit growth is being driven by banks lending to more marginal or highly indebted borrowers. In the June quarter, more than 20 per cent of new lending was to borrowers who had borrowed over 6x their pre-tax income — a historical and international high that’s projected to increase even further once lockdowns fully lift across the country.
This is a challenge because a highly indebted household sector means the market is less resilient to macroeconomic shocks in the future, such as an increase in interest rates or changes in household income. The APRA hopes that in increasing the buffer when the economy is on the rebound, it will be able to balance out any risks to the financial system.
“With lockdowns soon to be lifted, and expectations that the economy will bounce back, APRA considers the balance of risks has shifted such that a timely adjustment to serviceability standards is now warranted…In taking action in relation to mortgage lending standards, APRA is not seeking to target the level of housing prices. Rather, APRA’s objective is to ensure that mortgage lending is conducted on a prudent basis, and that borrowers are well-equipped to service their debts under a range of scenarios. ”APRA
5. The changes won’t stop here
These new lending rules mark the beginning of a broader response by the APRA and Council of Financial Regulators (CFR) in response to riskier lending policies from banks across Australia. The CFR has announced that the APRA will be releasing an upcoming information paper that will outline even more financial regulation policies and how to implement them.
The lending landscape is changing…
…and it’s going to be more challenging for borrowers looking to secure a home loan in the future. A trusted mortgage broker can help ensure the entire process goes as smoothly as possible, from seeking the sharpest rate on the market to submitting a successful application, settling your property purchase, and refinancing your loan.
With more than 20+ years of collective experience in mortgage broking, the Rateseeker team is here to help you navigate the changes and secure your dream home. Get started for free today with a no-obligation consultation.
** General Advice Warning
The information provided on this website is general in nature only and it does not take into account your personal needs or circumstances into consideration. Before acting on any advice, you should consider whether the information is appropriate to your needs and where appropriate, seek professional advice in relation to legal, financial, taxation, mortgage or other advice.