Are the buffers bogus???

I've just run some quick sums based on the borrowing capacity numbers quoted in this article:
Why falling property prices are actually bad news for first home buyers

It suggests a double income household ($90k each) with no kids could borrow $1.293m before the last rate rise, with rates at 2.98% and assuming a 3% buffer.

I'm a bit out of practice here, but is this really what the banks are assuming in terms of household costs?

At these numbers, annual mortgage repayments would be $65.2k, with combined after tax income of $136.9k, leaving $71.7k to live on. OK that sounds doable for most couples.

But if we test the buffer interest rate of 5.98%, the annual mortgage payments rise to $92.8k, leaving only $44.1k to live on... These seems like an extremely difficult ask for a couple who previously had $71.7k to live on. Their post tax, post mortgage income falls 38%, and the banks assume they are ok to that point.

I've heard the household spending assumptions are very low, but this seems unreasonably so.

Many seem to be assuming that because the buffers are in place, the market is fine until those buffer levels are reached. I'd say "Really??". Is it not likely that the market would be showing signs of extreme stress if rates just rose 2.5% for example, by which time this couple's post tax/mortgage income has fallen by over 31%?

Seems like there's been a case of joint delusion on sustainable household expenses, and or APRA has been more than happy to factor in a degree of household spending flexibility that ensures a very harsh recession any time rates need to rise more than a percent or two.

 

Buffers are for banks safety, not for mortgage holder convenience. If buffers hit for current loan holders, they need to extremely squeeze their spending and lifestyle.

 

Yes i get that, although i dont think the distinction is that significant. If the necessary cutbacks are so unreasonable, that will hit the banks in a number of ways, including feedback loops as these mortgagees lose their jobs due to the recession their spending cutbacks put us in.

There seems to be a flaw in the logic here. i'm not saying the expenditure assumptions should be so conservative as even at the limits of the buffers its easy, but i'd question what % of households could really pull that off.

 

Banks own your home. They will never go bankrupt if mortgagee go job less. It will be auctioned or write off as loss. These buffers are to satisfy regulation...banks will give 100%loan if they can. They are not on the moral scale to check flaws.

 

I read the article but didn't verify the figures. It does make sense.

Lenders borrowing calcualtors assess your new loan and existing loans based on the actual interest rate plus another 3%. In some cases the assessment rate would thus be above 6%. This is all regulated by APRA.

Personally I don't think rates will actually get to 6%, as noted that doesn't leave much for living. The economy would stall. I've seen estimates of the 'average' long term rate being anticipated at about 4.5%.

As for living expenses, my experience is that about 80% of people grossly underestimate what they actually spend.

The other thing to note is that most people earning $90k each don't have a $1.2M home loan.

 

Won't APRA reduce the buffers required once interest rates rise in order to avoid stalling lending and locking out a whole sector of the market by setting the fictional interest rate well above that which could be reasonably expected and factored into the market?

The original intent of the buffers were to prevent maxing out of the borrower's capacity and causing hardship should interest rates rise/return to normal levels why should they not review the condition that they have implemented.

 

Did these buffers also account for double digit inflation we are experiencing too?

 

TBH, neither of these are really what i'm concerned about, or the issue i am flagging.

1) i dont doubt the article's figures. They seem correct.

2) i'm not questioning whether or not rates go up 3%.

3) im not worried about banks going bust, or suggesting they would without these buffers, or that the buffers are to protect banks not borrowers.

The point is about systemic risk. APRA has put in a safety buffer of 2.5-3% because it believes that is a reasonable amount to assume rates could increase when they have to rise. But if that is based on dodgy assumptions for how much household expenditure can be squeezed, we dont really have a buffer of 2.5-3%. We have something less than that.

This has implications for everything. Bank's credit quality, housing market stability, broader economic resilience etc.

 

Yes probably, and that would help other new buyers. But it wouldnt help existing mortgagees who's break point is actually at a lower level of interest rate than expected.

Yes i realise there are a bunch of mitigating factors like offsetting balances etc. But the buffer of 2.5-3% is one of the key pillars of the housing market that is meant to hold things up when rates need to rise. It needs to work.

 

An unintended consequence of increased buffers would be low-middle income earners being priced out of the market due to serviceability. People will make cut backs and sacrifices as required.

 

That would make some sense, which is one of the reasons I don't think this will occur. APRA directives aren't necessarily based on logic.

APRA tend to be very pesimistic. If they have two options they'll take the more conservative even when it contradicts other rules. If rates get up to 6% they'll argue that they could go up to 9% with no consideration to the wider economic implications.

Inflation is accounted for in the living expenses component of the calcuations. This is based on the HEM indexes. These tables are reviewed frequently, thus they would take into account the effects of infation over time.

I agree that if rates do get to 6% it will be a disaster. Budgets can usually be cut, but there is a breaking point. This applies equaly to consumers and businesses. Some thing similar did occur in 2008 when rates got to 10%-11% and the economy couldn't support it. When RBA realised this, they cut rates by 5% within 4 months.

 

Maybe, but one could argue that the buffers, applied consistently , would result in lower valuations due to reduced purchasing power, meaning low-middle income earnings arent really hurt.

 

People with higher earnings will always have a higher borrowing capacity. I'm thinking of the cases where investors and first home buyers are competing for similar stock.

 

It might be a good exercise to have a look at the numbers pre-APRA to see what that looked like before they first introduced the 7% assessment rate (including what the HEMs looked like)

 

There’s also other buffers banks put in place not just assessment rates and hem.

Rental income is generally shaded to 70-80%. Along with overtime, allowances, commissions etc.

All in all this should give stability to the housing market in the short to medium term.

 

yep would love to see this data. Not sure it exists, but if anyone can point me in the right direction i'd be happy to crunch some numbers and publish the results on here

 

Agree, but neither helps your average FT employees who have borrowed whatever they can to buy their own home, surely the largest cohort among homebuyers.

 

What's the minimum hems amount for a couple 1 child, last I heard it was like 650wk? but it was a while ago so might be outdated.. alot of people scrounge on the spending for 3-6 months to look good to the bank and sneak in with the minimum hems amount to maximise borrowing capacity so the buffer rate becomes a non event for those households

 

Part of the issue for me is this hasnt been tested in decades. Rate increases have just never lasted long, nor got to higher than they were in the previous rate cycle, since the late 80s. So this 'buffer' strategy just hasnt been tested.

We dont know if the HEM is off, and really the buffer should be 3-4% to compensate for example.

In this housing market, everything has just been squeezed and resulted in maximum borrowing and maximum valuations: low HEM for buffer, based off zero rates, loan durations increased from 25yrs to 30, at best a couple of years of fixed repayments, usually variable etc etc etc. ITs just all been squeezed to the max.