Australia’s residential mortgage lending industry has experienced a staggering boom, up nearly 32% since last year, with house prices higher by 23% as well — indicating that borrowers are taking larger loans. With demand outpacing supply trends, the chances of the market developing a housing bubble increase every day.
There are three ways a housing bubble bursts:
- Economic Downturn
- Reduced Demand
- Increased Interest Rates
To avoid the negative impact Australia’s economy is bound to face following a bubble, the Australian Prudential Regulation Authority (APRA) analyses market trends and creates guidelines that direct lending institutions to make prudent decisions.
The new rules introduced by APRA follow a similar pattern to previous years that have minimal impact on owner-occupiers and limit lending growth to investors — 10% in 2014 and interest-only loans in 2017.
Here is what the new rules say.
What Are The New APRA Guidelines?
The Australian Prudential Regulation Authority (APRA) introduced new rules to strengthen the residential mortgage lending sector in October 2021. In effect from November, the guidelines aim to combat very low-interest rates and the fast-rising housing prices plaguing the industry.
Commonly, lenders today assess a borrower’s loan repayment ability at an interest rate of 2.5 percentage points above the loan product. The new guidelines dictate the need to increase this buffer to at least 3 percentage points to mitigate the growing financial stability risks present in residential mortgage lending in Australia.
Let’s dive right in to understand what is happening and how this change will affect owner-occupiers and investors.
What Does The New APRA Rules Mean For Owner-Occupiers And Investors?
Since highly indebted borrowers are less resilient to macroprudential shocks like reduction in income and increasing interest rates, a household sector that is highly indebted presents future financial stability risks that can inevitably lead to an economic downturn. To respond to these risks, APRA has raised the interest rate buffer that will filter out high-risk borrowers but is expected to be more favourable to owner-occupiers than investors. Here’s why.
Owner-Occupiers Borrow at Lower DTI Ratios Compared to Investors
The debt-to-income (DTI) ratio assesses a borrower’s repayment capacity by calculating their gross monthly income against their monthly debt payments, implying a low DTI offers a good balance between debt and income. In the quarter of 2021 June, around 33% of investors took out a loan with a DTI ratio above six, whereas, only 20% of owner-occupier borrowers had a similar percentage.
Although APRA could have introduced a DTI limit instead of the buffer, it would have falsely categorised many investors capable of repaying their loans because of four reasons:
- Investors have loans for multiple properties that make them more indebted in comparison.
- Tax incentives discourage investors from paying their property debt ahead of schedule.
- In the distribution of new borrowers, 35% of investors with a high DTI ratio have incomes in the top 40%.
- Investors with a DTI ratio above 6 have significant liquidity buffers compared to their owner-occupier peers.
So, a DTI limit would have restricted investors who are well placed to service their debt from borrowing. By increasing the mortgage serviceability buffer, APRA has enabled lenders to identify investors that have high DTI but low liquidity buffers.
Investors Have Multiple Properties
The increase in the mortgage buffer also applies to the borrower’s existing mortgage debts. Since investors are more likely to hold multiple properties — both personal and business — they are expected to be more negatively affected by the buffer than owner-occupiers who, constrained by the size of their deposit, borrow a high-multiple of their income.
What Can We Expect In The Future?
In November 2021, APRA released its framework for its macroprudential measures, which reiterated the buffer cap for residential mortgage lending and also introduced new guidelines that require ADIs to ensure that they can limit the extent of lending in the following loan type:
- DTI ratio greater than or equal to the 4 to 6 range
- Loan-to-valuation ratio greater than or equal to the 80-90% range
- A combination of any of two of the types specified above.
APRA’s measures, especially these most recent ones that differentiate between owner-occupier and investor loans — the latter being riskier — are part of a new wave of regulatory policies that have increasingly focused on curbing investor residential mortgage lending without affecting the owner-occupiers’ capacity to do so.
APRA says that it is likely to introduce more restrictions if the financial stability risk isn’t mitigated effectively.
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