The Australian Prudential Regulation Authority (APRA), took the first steps towards addressing the risks associated to ballooning debt. They mandated banks to apply higher interest rates when assessing mortgage applications.
According to the regulator, banks should have a minimum interest rate buffer of 3 percentage point (pps) above their loan product rates.
Banks used to use a minimum interest rate buffer of 2.5pps in the past.
This will reduce the maximum borrower’s borrowing capacity by about 5%.
The regulator predicts that this measure will have “fairly modest effects” on housing growth.
Council of Financial Regulators endorsed APRA’s actions. CFR expressed concern about the potential economic effects on the medium-term of household borrowing at a higher rate relative to income.
Wayne Byres (chairperson of APRA) stated that the increase in the minimum rate buffer was a targeted and judicious move to improve stability in the financial sector.
“In taking action, APRA is focused on ensuring the financial system remains safe, and that banks are lending to borrowers who can afford the level of debt they are taking on – both today and into the future,” he said.
Since more than half of new loans approved in June were over six times the incomes borrowers, Mr Byres believes it would be fair to establish higher serviceability standards to mitigate the risks.
“While the banking system is well capitalised and lending standards overall have held up, increases in the share of heavily indebted borrowers, and leverage in the household sector more broadly, mean that medium-term risks to financial stability are building,” he said.
Why did the minimum rate buffer for interest rates get increased?
In a statement, APRA stated that increasing interest rate serviceability was the best way to enforce stricter lending standards in current market conditions.
“It acts as a cap on leverage, is relatively easy to implement, and will not have any impact on mortgage interest rates.”
APRA stated, “An interest rate floor is not difficult to implement. It will not impact mortgage pricing.” However, it will be more restrictive on the part of owner-occupiers than it will be for investors.
“A limit on the extent of high debt-to-income borrowing would precisely target more highly indebted borrowers,” APRA said.
“Compared to raising the interest rate buffer, however, limits would be more operationally complex to deploy consistently, and may lead to higher interest rates for some borrowers as lenders effectively seek to ration credit to this cohort.”
It was noted however that it doesn’t rule out the possibility of using additional measures in the near future.
What are the affected borrowers?
APRA stated that all new borrowers will see the buffer increase.
It is more likely that investors will feel the impact than owners-occupiers.
According to the study, investors are more inclined to take out greater amounts of leverage than they have debts.
Tim Reardon from Housing Industry Association stated that APRA’s decision would make it more difficult to renters who hope to own a house.
These steps will make it harder to obtain a loan.
“This additional constraint is being imposed despite the share of loans with a 10% deposit or less declining since December 2020. This percentage is much lower than it was ten years ago.
Reardon said that changes in serviceability rules would have the greatest impact on first-home buyers.
“Restricting access to credit for new households seeking to enter the housing market will put further downward pressure on the rate of home ownership in Australia,” he said.