After reviewing the current guidelines, APRA has proposed that the 7% serviceability buffer on home loans be removed.
Interest-rate buffer history
Despite the low level of interest rates in Australia, many home-loan applicants are not able to get financing as they are assessed by lenders using a 7.25% interest-rate buffer — a practice that many believe is hampering growth in the housing market.1
APRA (Australian Prudential Regulation Authority) introduced the minimum interest-rate buffer of 7% in 2014 for all home-loan serviceability tests. However, most lenders apply a further 0.25% – 0.75% buffer as they assess their applicants. The minimum rate buffer has meant that some lenders have had to deny as many as one in five home-loan applications.1
In APRA’s view, the changes introduced in 2014 have served an important purpose by limiting excessive borrowing in an environment of low interest rates and high household debt. However, changes in the market and economic environment since that time have caused APRA to review the current guidelines.
Proposed change to serviceability
On the 21 May 2019, APRA proposed that the 7% serviceability buffer on home loans be removed.3
There are two ways that APRA requires a lender to assess home loans. The first is against a floor of 7%, and the second is to assess the loan at 2% above the actual rate paid by the borrower. The guidelines say to use whichever was higher i.e. 7%. Although APRA has proposed the removal of the 7% floor, the governing body has also recommended that the second buffer against the actual interest rate paid by the borrower be increased from 2% to 2.5%.
So what does this actually mean for you? Let’s say you’re applying for an owner occupied loan with an actual interest rate of 3.79%. Currently, the banks will require you to be able to service this loan at 7% minimum (keeping in mind most banks servicing rates are 7.25%-8%). The proposed changes will mean that you’ll only need to evidence your serviceability at a rate of 6.29% (2.5% higher than the actual rate being applied for). This would be close to a 1% drop in the assessment rate, which will greatly improve your ability to borrow.
A word from APRA
APRA Chair Wayne Byres says…
“APRA introduced this guidance as part of a suite of measures designed to reinforce sound residential lending standards at a time of heightened risk. Although many of those risk factors remain – high house prices, low interest rates, high household debt, and subdued income growth – two more recent developments have led us to review the appropriateness of the interest rate floor,” Mr Byres said.
“With interest rates at record lows, and likely to remain at historically low levels for some time, the gap between the 7% floor and actual rates paid has become quite wide in some cases – possibly unnecessarily so.
“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 been substantially reduced.
“The changes, while likely to increase the maximum borrowing capacity for a given borrower, are not intended to signify any lessening in the importance that APRA places on the maintenance of sound lending standards. Rather, it is simply recognition that the current interest rate environment does not warrant a uniform mandated interest rate floor of 7% across all products.4
When will this happen?
The proposed changes are subject to a four-week public consultation which closes on the 18 June 2019. APRA will release a final version of the updated guidelines shortly afterwards.
I’ll be sure to keep you posted as I know more.
If you have any questions about how this might impact your borrowing capacity, please don’t hesitate to get in touch with me anytime.