Home loan interest rates might be close to all-time lows. But with property prices surging at their fastest annual pace in more than 30 years, many borrowers are taking on bigger loans than ever before.
As a result, Australia’s main financial regulatory agencies are getting increasingly concerned with the rising levels of household debt. And, at the end of September, the agencies signalled a home loan crackdown could soon be on its way.
This, of course, begs three big questions:
Speculation is mounting that APRA, the banking regulator, will target debt-to-income ratios. Your debt-to-income ratio compares the amount of debt you take on with how much you earn.
Let’s say, for example, your pre-tax income is $100,000 and you take out a $400,000 mortgage. That means your debt-to-income ratio is 4 (i.e. $400,000 divided by $100,000).
APRA considers loans with a debt-to-income ratio of more than 6 “risky”. However, more than one in five new loans approved in the June quarter were at, or above, this ‘risky’ debt-to-income ratio, according to the regulator’s own statistics.
As such, there’s a good chance APRA will set a macroprudential rule instructing lenders not to issue home loans that exceed six times the borrower’s income
In the above example, that would mean that if you applied for a $650,000 mortgage, your application would be rejected, as your debt-to-income ratio would be above 6 (as $650,000 is 6.5 times greater than $100,000).
While nothing is set in stone, many analysts expect the new rules to be announced before the end of this year.
At the moment, it’s a good time to be a borrower in Australia, thanks to record-low interest rates that mean it’s never been cheaper to service a home loan.
However, it’s unlikely rates will stay this low forever. So APRA wants to make sure borrowers can still service their loans when rates rise in the future
The problem is, the property boom has led to ballooning loan sizes as Australian borrowers take on more debt to keep pace with soaring prices. As a result, housing credit growth has surged, with Reserve Bank data showing it rose 6.2% over the 12 months to August.
In direct contrast, wages grew 1.7% over the 12 months to June.
This imbalance is leading to big increases in household debt, which is potentially risky for borrowers and the financial system.
It’s impossible to say what impact these tougher lending rules will have on property prices.
However, it’s unlikely to be anything too dramatic – as four out of five borrowers won’t be impacted at all by these rule changes, according to APRA’s own statistics.
At the same time, Reserve Bank governor Philip Lowe has repeatedly maintained the cash rate is unlikely to rise “before 2024”.
Rock-bottom interest rates have been one of the biggest drivers of strong property price growth.
In related news, APRA recently told lenders to increase their home loan buffer from 2.5 percentage points to 3 percentage points.
This means the lender will have to test if you could cope if rates rose by 3 percentage points. So if you were applying for a loan at 2.15%, the lender would assess you as if you were applying for a principal-and-interest loan priced at 5.15%.
APRA estimates the move will cut your maximum borrowing capacity by around 5%. So if you could borrow a maximum of $600,000 under the old rules, this would fall to $570,000.
However, “as many borrowers do not borrow at their maximum capacity”, the regulator expects the tighter rules to have only a “fairly modest” impact.
In the letter to banks explaining the rule changes, APRA said:
“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.
“More than one in five new loans approved in the June quarter were at more than six times the borrowers’ income, and at an aggregate level the expectation is that housing credit growth will run ahead of household income growth in the period ahead. With the economy expected to bounce back as lockdowns begin to be lifted around the country, the balance of risks is such that stronger serviceability standards are warranted.”