How APRA Will Reduce Your Borrowing Power

With house price growth approaching multi-decade highs, regulators are now planning reductions to overall borrowing capacities. We expect interventions may lower owner occupier borrowing power by 15% and investor borrowing power by around 10%.

On balance, lending standards remain robust despite increasing house prices. There has been an increase in the number of borrowers with high debt to income ratios and ‘small’ servicing buffers. This creates additional risk associated with borrower’s ability to repay, increasing the risk of default. Therefore, a targeted policy that strengthens borrowers’ buffers and reduces debt to income ratios are the likely interventions.

Figure 1: Overall 'loan to value' ratio risks are low and falling, therefore deposit limitations are unlikely. Interest only loans are low, therefore unlikely to be targeted An increasing proportion of high DTI ratio loans are the main emerging risk. Source: RBA, APRA

What will they do?

Option 1: Increasing the assessment rate buffers banks use to assess your borrowing capacity

In mid 2019 APRA removed the ‘floor’ buffer on assessment rates and allowed a floating assessment rate of 2.5% above the interest rate. This boosted borrowing power by 20%+. Interest rates have fallen further since then and some banks have assessment rates around 5%.

They may reintroduce a minimum floor rate. This level will need to be around 6.5% to get DTI ratios below 6.

If done, this will result in a 10-15% reduction in borrowing capacities.


Figure 2: Based on a couple earning $100k each, 2 kids, min expenses and a $6k CC. Borrowing power currently is around $1.45mill, and will fall to around $1.22mill to keep their DTI < 6. This is a 15%+ fall in borrowing power.


Figure 3: Based on a couple earning $100k each, 2 kids, min expenses and a $6k CC renting at $400 per week, 80% LTV loans, 4% rental yields. Borrowing power currently is around $1.85mill and will fall to around $1.7mill to keep their DTI < 6. This is around a 10% drop in investor borrowing power.

Option 2: Non-bank compliance measures

Most 'ADI' lenders follow the lending guidelines set out by APRA. Some non-banks deviate from APRA guidelines, which helps investor borrowers. This allows ‘portfolio’ planning by investors to potentially double their individual lender borrowing capacity. The regulators may force more compliance here.


Figure 4 – Non-banks (aggressive lenders) have been able to lend more to those with existing debts (investors). This has allowed investors to structure their portfolios to 'double' their individual APRA regulated lender borrowing capacity by utilising favourable non-bank lenders. That is, if a big 4 bank had offered you $2million in lending, you could take this and obtain another $2million by working with mid-tier and aggressive lenders afterwards. APRA may crack down on this and force compliance. This would reverse this change and reduce debt to income ratios of portfolio investors. If implemented, this change will impact investors and existing debt holders looking to upgrade their property.

Option 3: DSR ratios

Regulators could give banks license to cap the number of loans they accept at higher DSR ratios. This will offload the credit risk onto banks and allow good borrowers to obtain higher DTI loans. They may price these loans higher, take on a small cap (10%) & come up with their own policies.

This would be a prudent way to achieve this than generalised caps noted above. This would have a similar impact to Option 1, albeit with more flexibility for strong borrowers. It would distort the market less and have a smaller impact overall.

What impact will this have on the market?

Overall, this should slow the market growth down and segment it too. However, it is not as big as prior macroprudential interventions. Any of the above changes only impact new loan serviceability. The 2015 experience with borrowing capacity cuts showed that these types of changes only had a temporary slowing of the marketplace. Big structural changes to loan repayment types and removing liquidity from the market was a bigger handbrake to the market then (cutting IO lending in 2017). Segmenting to micro markets:

• It will impact Sydney & Melbourne more than any other location.
• This type of change will hit the 800k – 2mill market more so than lower value markets, where borrowing capacities are often more stretched. Lower priced markets are less likely to be impacted by DSR ratios as borrowers borrow less.
• Given demand for property is still attractive, it will likely alter buyers to be pushed the next suburb out rather than out of the market altogether.
• Prices are still attractive relative to the cost of credit; prices will continue to adjust until they reflect the permanently lower cost of credit (neutral cash rate has fallen from 3-4% to 1-2% in the last few years).

How to prepare for this:

• If you plan on maximising your borrowing capacity – it may be worth doing so sooner rather than later. This is likely to be particularly a Sydney (and Melbourne) owner occupier borrower looking to maximise.
• If you are an investor seeking to increase your portfolio, plan for a 10-15% reduction in your current borrowing capacity.

On balance, lending data suggests that runaway price growth is not being driven by loosening credit standards. Instead, it is underlying fundamental conditions like the cost of credit, higher net incomes, affordability & higher savings balances leading to increased demand. The lending data doesn’t suggest that these changes are necessary at this point, but the politics of rapidly rising house prices may bring them to light sooner than expected.

 

Great post Redom.

Noticed that all of the major banks have come out today requesting APRA to apply any new rules to non-banks as well to "stop capital moving to unregulated sector to fund the demand".

 

This is the MAIN point here. Who wants to bet this doesn't slow the market?

The fundamentals is simply cash is worthless and credit is cheap. Until interest rates rise again to significant levels and quantitative easing is reduced significantly ppl will continue to pour money into investments and Real Estate is leading the charge.

APRA/RBA they can try to help the situation but this is a GLOBAL boom. Every single 1st world country is having an asset boom. Each and every single one.

 

I agree with this, looking closer into the data and lending, its all fairly robust at the moment. We are not in a speculative asset bubble from poor lending standards, or have any material origination issues that I notice.

The fundamentals of this property price appreciation (and global) is a reset to lower interest rates. Asset prices are simply adjusting to a much much lower long term cost of credit. Tapping the brakes on borrowing capacities aren't strong enough to stop this (e.g. a borrower can get a loan at high 1's, while yields are 3s). Altering the cost of credit will be required to actually stop this change.

 

I've heard that the stock market is unusually high and ready for a correction. Money in the bank will go backwards with inflation. Buying property going forward I would choose carefully -don't feel under pressure to purchase a property that will perform poorly in the downturn. Cars - Gees, I didn't think I'd see this in my lifetime. Daughters first car that she purchased for $12,000 three years ago is now worth around $17,000. My son is upset he wanted to purchase a car for $5000, two years ago is now selling for $15,000 in worse condition.

 

Great post Redom.

Do you happen to have any data around the DTI ratios in each of the states? I'm guessing Sydney and Melb would be higher, hence your suggestion that it will affect these markets the most.

Thanks

 

Easiest method as you mentioned are dti ratios -banks being required to implement a cap.

Interesting times ahead in both the lending space and as a result the property market. Even more of a reason to work with an experienced broker- tapping out of majors and moving into non-confirming space to keep on growing.

 

I based it largely of loan sizes relative to incomes.
Serviceability generally is less of an issue for owner occupier borrowers in Adelaide/Brisbane. Debt to income ratios are considerably lower in those cities, hence this type of change should impact Sydney/Melbourne markets more (which typically correlate closer with macro financing conditions).

 

This is exactly what the Big 4 are worried about....Sydney and Melbourne. If this keeps going ...a vein is going pop!

As I said....Brisbane, Adelaide, Perth might be affected but the top 7 banks in Australia will be focusing on ensuring that their asset quality is resilient to any shocks. And the biggest concern is the debt levels and should there be high unemployment. A lot on here have never seen what can happen if the trifecta happens.....global recession.....high unemployment...and lack of liquidity. Not saying it will happen now...but when the money supply pull back in the next 18 months...have a look at COVID cases, deaths, and vax rates globally...we will be pretty much be controlling it and living with it globally by 2023. The you see people spend like crazy what they save ...holidays...cars...economics boom.....2004-2005.....govt ..banks...pull in credit...the question is what happens next....

 

The majors come across as so self serving in suggesting knee-capping their competition!

You might have seen Matt Comyn get all high and mighty about moving the CBA assessment rate 0.15% higher (lols)

 

What they will target.

 

That might be only the first step. What happens if they implement post code related financing constraints or limit lending over certain amounts unless you havea 30% deposit. Just look over the ditch.. .for clues.

I reckon a lot more tightening to come the big 4 have large loan books and will not want their asset quality diluted.

 

Facts are facts! As you said cash is worthless and even ABC News pointed when interest rates drop prices go up. This will simply push ppl to a cheaper suburb in the city they choose to live, or stump up more funds. The savings rate has been ramping up like crazy since lockdown, just like last lockdown. Every western world country is booming like Australia and will continue to do so.

 

Agreed! pre 2015 you could borrow substantially more than today on the same income, with much less paperwork or insights into all spending. Some people will be knocked out to what they want to buy and in a way forced to rent, so rents could go up slowly especially when boarders open. Just got to watch build pipeline.

 

How much does everyone thing this will impact the Sydney market?

Will a $1m home go to $800K, a $2m go to $1.5m, how about a $5m go to $4m?

I recently got a pre-approval from CBA of $1.7m for an IP (note that I already have circa $1m in Investor Loan). The total $2.7m is well above X7 DTI.

 

I dont think we will see a drop in prices across the board. The ultra top end will see some slight reduction with thinning out of buyers

Middle market will be flat lined, but I feel the lower end will still have some growth given affordability. Eventually as time passes on, this will ripple onto middle markets given where cheaper markets have closed the gap over time.


tl, dr;

my personal take is generally markets will still tick along. We just wont see any silly growth what Sydney has been seeing in past 12-18 months which I think is the right move long term

 

And we have some clarity on the when: likely in the next couple months, may take a bit longer for implementation.

“Over the next couple of months, APRA also plans to publish an information paper on its framework for implementing macroprudential policy.”

 

Who says there is going to be a drop in prices? Fundamentals of the economy and cheap credit globally wont change with CBA or the other banks raising their serviceability by 0.15%. LOL

Like I said they will "try" or seem like they are actively doing "something" to ease the pain but it probably wont eventuate to anything meaningful or substantial.

 

A DTI of 6 on a single PPOR is very different to a DTI of 6 on income producing IPs. I suppose discouraging investors "who push prices up" is part of the agenda.

A big proportion of property investors (and many FHBs in Sydney/Melbourne in recent times) would have DTIs >6. So we'll be stuck with our current lenders for years to come while they become uncompetitive because they can?