The Reserve Bank of Australia warned of the potential dangers of Australian borrowers being too optimistic about the current housing market.
Low rates are responsible for high house values, according to the RBA’s Financial Stability Review.
The report said that vulnerability can increase in the event of an exuberant housing market, where borrowers take on greater risks because they expect higher prices and banks may relax lending standards.
These risks are being addressed by the Australian Prudential Regulation Authority.
Recent updates to regulator’s mortgage macroprudential strategies (MPP) saw an increase in interest rates buffers from 3 percentage points (pps), to 3.
What is Australia’s macroprudential strategy in comparison to other advanced economies?
According to RBA, macroprudential strategy have been gaining prominence in recent years because of the global financial crisis.
It stated that it was a reflection of prolonged periods at low interest rates in various countries to stimulate economic development.
The RBA states that Australia and other advanced economies have taken various measures to reduce their lending.
These measures often take into account the structure of lending and housing markets, implementation cost and competition concerns, as well as distributional consequences for borrowers.
The restriction on serviceability, loan-to-value ratio (LVR) and debt to income ratio (DTI), are the most popular MPPs internationally.
Serviceability restrictions are used in order to restrict lending to borrowers who do not have sufficient income to cover basic living expenses.
Lenders who limit loan amounts by using interest rates may be subject to serviceability restrictions
These restrictions include the setting of interest rate buffers and floors as well as limiting debt servicing expenses relative to income.
One example is APRA’s recent decision to increase the interest rate buffer. This will likely decrease the maximum borrowing capability by 5%.
These measures will ensure that borrowers can service their debts even if interest rates rise.
Restrictions on DTI Ratio
These restrictions restrict the amount of money that households can borrow relative to their income.
These restrictions will limit the borrower’s debt-servicing expenses so they have greater cash reserves to pay back their loans.
High DTI ratios are a problem in Ireland and the United Kingdom.
LVR restrictions limit the amount of money that may be borrowed relative to the property’s worth.
This MPP restricts credit availability for borrowers with low equity.
LVR restrictions can be used in many countries to target specific risks.
LVR restrictions in New Zealand are in effect for investors at 60% and owners-occupiers at 88%.
Sweden has an LVR limit for investors and owners-occupiers of 85 percent.
What effect will the new rules by APRA have upon the industry?
Raj Ladher, a specialist in mortgages, said that APRA’s recent decisions would likely have “little impact” on owner-occupiers.
The higher investor rates will make the impact feel more acutely for investors. I believe this is what the regulators are trying to curb to begin with,” he said.
Angus Moore from REA Group, economist, shared similar thoughts. He stated that the impact of the move on individual borrowers is dependent on two factors.
The change will not affect the maximum borrowing capacity. He explained that not all people borrow as much as they could.
Moore used data from CBA to show that around 8 borrowers borrow up to the maximum limit.
According to him, any borrower with a lower maximum borrowing capacity will be able to borrow as much as they want under the new changes.
The second is interest rates.
Moore explained that lenders who are capable of accommodating the changes in serviceability regulations can either assess borrowers at three pps higher or use the floor rate (currently 5%).
“This floor means that the new higher buffer only affects new borrowers whose mortgage interest rates are above roughly 2% — depending on the floor the lender uses,” he said.
This means that borrowers who have interest rates greater than 2.5% will be more affected than those with rates between 2.5% and 2.5%.
APRA’s recent move, however, was just the start. Recent statements by the regulator suggested that they would soon publish an information paper outlining their overall framework for macroprudential policy. This will include mortgages.
“With all these official publications about measures and how to implement them, it seems very likely that further changes are coming to curb lending that the regulator views as risky,” Mr Moore said.