The RBA has warned the community not to expect instant results from the banking regulator’s move to tighten home loan application tests, with the changes potentially taking months to filter through to a cooler property market.
In its latest Financial Stability Review (FSR), published on Friday, the Reserve Bank said it was likely to take a few weeks for the changes to even filter down to many home loan applicants.
“The maximum impact of this policy change could take several months to be realised,” it cautioned. “It may take some lenders several weeks to adjust to the new settings and some households will have already planned or committed to purchase based on previous lending policies.
“Indirect effects may take even longer than the direct effects, although changes in potential buyers’ expectations could bring forward the impact of the policy change.”
The policy change referred to was the banking regulator APRA’s move on Wednesday to increase the interest rate buffer on their mortgage serviceability tests for loan applicants. It told banks that, from November 1, households must be capable of making mortgage repayments if home loan interest rates rise 3 percentage points above their current rate, rather than the previous 2.5 percentage points. APRA estimated that, for most borrowers, this change would cut their maximum loan amount by around 5 per cent. So, for example, if under the old rules the maximum someone could borrow was $500,000, the maximum they would be able to borrow under the new rules would be $475,000.
However, the Reserve Bank noted that the effect could be greater for some groups of borrowers than others.
“For a given income and initial net income surplus, the effect on borrowers with existing mortgage debts (such as investors) would be larger, as the increase in the serviceability assessment rate also applies to a borrower’s existing debts,” the FSR noted.
“Estimates from survey data suggest that FHBs [first home buyers] are more likely than other owner occupiers to take out a loan that is very close to their maximum. While this suggests that FHBs are more likely to be constrained than other owner-occupier borrowers, the overall share of FHBs that will be affected is estimated to be very small.”
The Reserve Bank produces its FSR twice a year and has been alert to the risks posed by Australia’s latest housing boom for some time.
Its previous FSR in April warned about the extraordinary run-up in house prices and debt in Australia.
It noted the housing boom could pose a threat to financial and economic stability if it was not managed properly and resulted in riskier lending.
“Risks from rising asset prices and debt could build, particularly if lending standards are weakened,” it cautioned.
“Persistent increases in asset prices could lead to expectations rises will continue and so increase risk taking and borrowing, especially given low interest rates.
“This could push asset prices above their fundamental values, which could lead to a correction in asset prices, which, if borrowers’ income fell, could expose lenders to large losses on higher debt.”
In the 12 months to September, property prices surged more than 20 per cent.
Recent data from CoreLogic appears to show that the peak growth rate in property prices has passed, although the most recent monthly growth rate would still have prices rising 18 per cent a year if it does not slow further.
The Reserve Bank has warned that the Council of Financial Regulators it sits on with APRA would be prepared to take further action if the property boom continues to drive strong home lending growth.
“Over time, if the extent of systemic risk changes, then the MPP [macroprudential policy] settings may need to be adjusted, as has frequently been the case internationally,” it noted.
“The nature of risks at that time would determine what types of MPPs might be best suited to the situation.”
One option that has been publicly canvassed by the RBA, and is being investigated by APRA, is the imposition of limits on high debt-to-income (DTI) ratio loans, such as where the loan is more than six times the borrower’s income.
Such restrictions already exist in the UK and Ireland.
“APRA data indicate that restrictions on high-DTI lending would constrain a larger share of investors than owner-occupiers,” the FSR noted.
“Around one-third of investors took out a loan with a DTI ratio above six in the June quarter of 2021, compared to around 20 per cent of owner-occupier borrowers.
“Investors tend to be more highly indebted as many have loans for multiple properties [e.g. they may have both an owner-occupier and an investor loan, or multiple investment loans] and tax incentives discourage them from paying down the debt on their investor properties ahead of schedule.”
Unlike DTI limits, restrictions on loan-to-valuation ratios, like those currently imposed in New Zealand, tend to have a greater impact on owner-occupiers, especially first home buyers, according to the RBA’s research.
“In the June quarter of 2021, around 10 per cent of new owner-occupier loans had an LVR at origination above 90 per cent, compared to only 4 per cent of investor loans,” the FSR observed. “In the [same time period], over a quarter of loans to FHBs were originated with an LVR greater than 90 per cent, compared to around 10 per cent for other owner-occupier loans.”