Fletcher Rowe | May 30 2019
Last week, the Australian Prudential Regulation Authority (APRA) announced a change to the serviceability buffers that all deposit-taking institutions are required to abide by when assessing a borrower’s ability to repay a home loan.
The buffer, in place since 2014, is designed to ensure borrowers are able to continue to repay their loans, even if interest rates were to rise.
Currently, APRA recommends lenders assess the ability to meet repayments at an interest rate of the higher of: 7.00%, or 2.00% above the actual interest rate offered.
Then, just to be especially prudent, they expect lenders adopt a buffer that is ‘comfortably above’ this minimum.
Today, almost all banks will assess your ability to repay your home loan at 7.25%.
IFA Mortgages & Finance strongly supports the use of a serviceability buffer – it protects borrowers by reducing the likelihood of them going into financial hardship as the market moves over time.
Of course, the market today is vastly different to it was in 2014. Since the buffer was introduced, the Reserve Bank has reduced the cash rate target 4 times, and it now sits at a record-low of 1.50%. The buffer has served its purpose in limiting excessive borrowing in a period of low interest rates and relatively high household debt.
In light of this, APRA is proposing a reduction in this floor rate of assessment to better reflect the current lending environment and the expectation of a low interest rate environment that could linger for longer than initially expected. It is proposing:
- The removal of the 7.00% minimum assessment rate;
- The removal of the expectation that banks would adopt a rate ‘comfortably above’ this minimum;
- Instead, banks would be required to adopt a buffer of at least 2.50% above the offered interest rate, with banks able to increase this buffer to accommodate their desired portfolio mix and appetite for risk.
For a home loan currently on offer at 4.00%, the bank would assess the ability to repay this debt at 6.50%.
The other advantage of this change is that it naturally accounts for the variation in rates offered between owner-occupied loans and investments, with investor interest rates usually higher than those buying their first home to live in.
In this case, the investors would be assessed at a higher rate than those buying their own home.
The proposed changes are likely to see an applicant’s maximum borrowing capacity increased, and importantly, their maximum borrowing will be directly impacted by the rates on offer at our banks. If rates were to increase, there would be a concomitant reduction to their borrowing power, and vice versa.
In our view, the proposal more appropriately reflects the changing risk presented by a changing market. It does not reduce the need for banks to ensure prudence in their assessment of a loan application, nor does it signal any lesser focus on the adherence to responsible standards of lending. It simply acknowledges the changes in the landscape that have occurred over the past 5 years since the buffer was introduced.
The proposals have been opened for a 4-week public consultation, during which time they will welcome feedback to the draft revisions.
APRA expects to formalise any arrangements shortly after the June 18 deadline for submissions.
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