The Australian Prudential Regulation Authority has confirmed that it will drop the requirement that lenders assess home loan applications using a minimum interest rate of 7 per cent. Commentators say there will be a positive impact for borrowers but it will be offset to some extent by other changes to lending standards
APRA flagged the change in May and last week confirmed that it would drop the provision from its guidance on mortgage serviceability assessments.
Instead of the 7 per cent floor (which is 7.25 per cent in practice), banks and other authorised deposit-taking institutions will be permitted to review and set their own minimum interest rate floor for use in assessments.
APRA wants lenders to increase the interest rate buffers they use in their assessments from 2.25 per cent to 2.5 per cent.
UBS economist George Tharenou says the change will notionally increase borrowing capacity by around 8 per cent, but a move to full verification of living expenses could offset APRA’s easing.
“This materially reduces downside risk for housing and the economy but given ongoing expense verification plus expected rollout of comprehensive credit reporting and debt-to-income limits, it’s unlikely to reflate housing on its own,” Tharenou says.
CoreLogic research analyst Cameron Kusher says the impact of the change will be positive for borrowers and the housing market but he also sees much of the benefit being offset by other changes.
Kusher says the expansion of comprehensive credit reporting, which gives lenders more information about borrowers, could make it harder for people with histories of late payments to get credit. And the introduction of the new Banking Code of Conduct sets higher standards for lenders.
The 7 per cent rule has been in place since December 2014, when APRA also introduced the interest rate buffer and the 10 per cent limit on growth in new lending to investors.
In March 2017, APRA said it expected ADIs to limit the flow of new interest-only lending to 30 per cent of new residential mortgage lending.
It also told ADIs to place “strict internal limits” on the volume of interest-only lending at loan-to- valuation ratios above 80 per cent, and “ensure there is strong scrutiny and justification” for interest-only loans at LVRs above 90 per cent.
In April last year, APRA started to ease the restraints. It removed the investor loan growth benchmark, although the change would only apply to ADIs that had “contained their growth and are able to provide assurance on the strength of their lending standards.”
In December, it removed the interest-only benchmark (with effect from 1 January), again with a caveat that ADIs needed to confirm lending policies and practices that met APRA’s expectations.
In May, when APRA flagged the latest change, chair Wayne Byres said the operating environment for ADIs had evolved since 2014, prompting APRA to review the ongoing appropriateness of the current guidance.
Byres said: “APRA introduced the guidance as part of a suite of measures designed to reinforce residential lending standards at a time of heightened risk. Although many of tose risk factors remain – high house prices, low interest rates, high household debt and subdued income growth – two more recent development have led us to review the appropriateness of the interest rate floor.
“With interest rates at record lows and likely to remain at historically low levels for some time, the gap between the 7 per cent floor and actual rates paid has become quite wide in some cases.
“In addition, the introduction of differential pricing in recent years – with a substantial gap emerging between interest rates for owner-occupiers with principal and interest loans on the one hand, and investors with interest-only loans on the other – has meant that the merits of a single floor rate across all products have substantially reduced.”