APRA cracks down on lending amid household debt concerns

The banking regulator has increased the minimum interest rate buffer banks must use when assessing a home loan application to ensure borrowers aren’t overstretching themselves.

The Australian Prudential Regulation Authority (APRA) said lenders are expected to lift their serviceability buffers by 50 basis points, from 2.5% to 3%.

It means that lenders must assess whether borrowers would still be able to meet their repayments on an interest rate that is at least 3% higher than their current interest rate, or the ‘floor’ rate set by the bank, whichever is higher.

Why the measures have been introduced

APRA doesn’t specifically target housing prices, but it does have a responsibility to promote safe and secure lending practices.

Overall, it says lending conditions remains sound, however there are signs a growing number of borrowers may be overstretching themselves to secure a property in the hot housing market.

While record-low interest rates, government stimulus and limitations on how people can spend their money during the pandemic have allowed existing borrowers to pay down their mortgages faster, many new borrowers are taking on bigger loans.

Lending data from the Australian Bureau of Statistics shows $30.76 billion worth of new home loans were issued in August, 47.4% higher than a year ago.

The average mortgage size for people buying a home to live in grew by 16% nationally over the past year, an increase of roughly $80,000 per loan. In New South Wales and Victoria, mortgages have grown by more than 20%.

APRA chair Wayne Byres said the serviceability measures would ensure banks are lending to borrowers who can afford the level of debt they are taking on “both today and into the future”.

“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,” Mr Byres said in a statement.

What it means for borrowers

The increase in the interest rate buffer applies to all new borrowers, reducing the maximum amount people can borrow to buy a home.

It’s estimated the measures will reduce the maximum borrowing capacity for the typical borrower by around 5%.

APRA said the overall impact on aggregate housing credit growth was expected to be “fairly modest” given some borrowers are already constrained by the floor rates that lenders use, and that many borrowers do not borrow at their maximum capacity.

But realestate.com.au economist Paul Ryan said a 5% reduction is a significant amount.

“A surprisingly small number of borrowers actually go up to their limit, but it does filter down in its effects,” he said.

Under the measures, a household that could previously borrow a maximum of $500,000 will see their borrowing capacity fall by around $25,000 to $475,000.

Australia’s largest lender, the Commonwealth Bank, said 8% of home loan applicants borrowed at their maximum capacity during the first half of 2021.

Who will be most impacted

APRA said the impact of a higher serviceability buffer is likely to be larger for investors than owner occupiers because, on average, investors tend to borrow at higher levels of leverage and may have other existing debts to which the buffer would also be applied.

The regulator said first-home buyers tend to be under-represented as a share of borrowers borrowing a high multiple of their income, since they’re often more constrained by the size of their deposit.

However, Mr Ryan said he expected the changes would also hit those seeking to get onto the property ladder.

“First-home buyers will be impacted more than most, because they tend to borrow at higher capacities,” Mr Ryan said.

“This will crimp access to the market even more for those people stretching to get to get on the ladder.”

Mr Ryan said other targeted measures, such as imposing restrictions on high-debt borrowers, would have a greater impact on investors.

What it means for property prices

Property prices have surged over the past year, and economists are mixed on what impact they expect these measures to have on future growth.

Mr Ryan said he expected the measures would have a meaningful impact on house price growth.

“It will act to slow down the housing market without having an operational impact on lenders,” Mr Ryan said.

“Marginal borrowers who were borrowing at their limit now have less to borrow.

“It’ll also work through people’s expectations. If they can’t borrow as much as they were able to, people may expect lower housing price growth in the future and so they may bid up houses a little less strongly than they have been,” he said.

CBA economist Gareth Aird said while the increase to interest rate buffers would reduce the amount some borrowers could access, the bank didn’t expect it to materially shift the outlook for home prices in 2022.

“To be clear, the policy change will result in some future applicants borrowing less money than they would have otherwise,” Mr Aird said.

“But our initial assessment is that current momentum in the housing market is sufficiently strong that the overall impact on dwelling price growth next year will be modest.”

CBA economists expect national dwelling prices to rise by 7% in 2022, on the proviso that there are no further policy changes from APRA with regards to home lending.

Will further measures be announced

APRA has not ruled out introducing further measures.

In its statement, APRA said regulators would “continue to closely monitor risks in residential mortgage lending, and can take further steps if necessary”.

It said raising the interest rate buffer was the preferred response “on this occasion” and hasn’t ruled out that “other measures might be used in the future”.

Mr Ryan said he expected more targeted measures aimed at high-debt borrowers to be implemented in December or early next year.

“The rate buffers will reduce everyone’s debt capacity followed by debt-to-income measures, which target specific types of buyers that might be engaging in speculative activity, like investors,” Mr Ryan said.

Data from APRA showed 22% of new mortgages issued in June had a debt-to-income ratio greater than six, up from 16% a year earlier.

Mr Byres said housing credit growth is being driven by lending to more marginal and highly indebted borrowers.

“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,” he said.

“This is high by both historical and international standards – and without action, the share is likely to increase further.”

Previous restrictions by APRA imposed caps on investor lending, but Mr Ryan said he doesn’t expect that to be repeated this time around.

“Because the investor share of new lending is very low, I don’t think regulators are concerned about investors per se. They’re concerned about high-debt investors so that’s why they’re leaning towards a high-debt measure to better target the types of investors they’re worried about,” Mr Ryan said.

“Mum and Dad investors investing in a second property is not their concern, it’s highly leveraged people investing in their 10^th or 11^th property they’re worried about,” he said.

ANZ economist David Plank also expects further measures given the strength of the housing market.

“In the context of the current strength of the housing market this is a modest change,” Mr Plank said.

“As such, further macroprudential tightening seems more likely than not. But not before the Council of Financial Regulators has had time to assess to the impact of this move.”

However, Mr Aird doesn’t expect to see further intervention.

“Additional changes cannot be ruled out,” he said.

“If it turns out to be the case that the housing market is still causing the Council discomfort in 2022 the most likely policy response would be to further increase the minimum interest rate buffer.

“At this stage we consider that unlikely, particularly given we expect fixed mortgage rates to drift higher over 2022.”

APRA plans to release an information paper on its framework for implementing macroprudential policy later this year.