The Australian Prudential Regulation Authority (APRA) has announced proposed changes. The changes may mean more people could access home loans and your borrowing power could increase.
The current situation
Before we break-down the proposed changes, let’s have a look at the current situation:
When you apply for a home loan, the bank or lender you want to borrow the money from assesses whether or not you’ll be able to meet the loan repayments.
The bank/lender puts your loan application through a number of tests as part of their assessment.
When they test your ability to afford the loan repayments, they test it at a higher interest rate than the loan’s actual interest rate.
Amanda and Dan are applying for a home loan with a 3.75% interest rate. When the lender tests their ability to repay the loan, they don’t actually calculate the repayments at the 3.75% interest rate. They test it at a higher interest rate. This creates a buffer, to ensure that if interest rates rise Amanda and Dan will still be able to make your loan repayments.
Currently, APRA’s serviceability guidance is that banks and lenders need to test your ability to make your loan repayments against at least a 2% buffer on top of the loan’s actual interest rate or a 7% interest rate (interest rate floor). The bank/lender must test the repayments against whichever is highest out of the two options (2% buffer or 7% interest rate floor).
This serviceability guidance appears in the Prudential Practice Guide APG 223 Residential Mortgage Lending
APRA’s serviceability guidance also indicates that a prudent bank/lender should use rates comfortably above these minima; most banks/lenders use a 7.25 % interest rate floor and a 2.25% buffer.
So, if we go back to Amanda and Dan’s home loan application:
They’re applying for a home loan with an interest rate of 3.75%. When the bank/lender assesses their ability to repay the loan they’ll test it against at least a 7% interest rate.
APRA supervises institutions across banking, insurances and superannuation.
The reason APRA originally introduced the buffer and the floor was to ‘reinforce sound residential lending standards at a time of heightened risk.’ – APRA Chair Wayne Byres.
What are APRA’s proposed changes
Under the proposed changes, bank/lenders would be allowed to review and set their own minimum interest rate floor when assessing home loans.
APRA has also proposed that banks/lenders serviceability assessments incorporate an interest rate buffer of 2.5%.
APRA is proposing that the Prudential Practice Guide APG 223 Residential Mortgage Lending, in which the serviceability guidance appears, be amended.
Why is APRA proposing changes to the interest rate floor?
The interest rate floor was introduced in 2014. The financial and interest rate environment has significantly changed since then.
“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 – possibly unnecessarily so.” – APRA Chair Wayne Byres.
What do the proposed changes mean for you?
The proposed changes will likely increase your borrowing potential and give more people access to home loans.
Lowering the interest rate floor by even 1% could take off approximately $60 per week of the assessed repayment on a $400,000, 30-year loan.
Let’s see how the changes would affect Amanda and Dan’s home loan application:
Amanda and Dan have a household income of $109,688. They would be able to borrow up to $60,000 more if their loan was assessed at 6.25% instead of 7.25%
These changes don’t mean there will be a borrowing ‘free-for-all’. Responsible lending still applies. It will still be more difficult than in the past to get a home loan because of other elements of the loan assessment have tightened.
What happens next
A four-week consultation will close on 18 June. APRA will release a final version of the updated APG 223 shortly afterwards.
I’ll keep you posted. If you have any questions about these changes book a chat with me and I’d be happy to help you.
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