The 7.25% assessment rate and the future.

Discussion in 'Investment Strategy' started by Beelzebub, 13th Apr, 2018.

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  1. Beelzebub

    Beelzebub Well-Known Member

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    I'm wondering, do the banks see the 7.25% assessment rate as primarily providing for a buffer or is it more geared towards the average interest rate over time?

    Essentially, I noticed that the average RBA rate over the last 28 years has been 4.6%, if you then add the banks margin you end up with something around the 7% mark.

    So, if the current RBA rate is 1.5% and the assessment rate is 7.25% will APRA want the buffer to stay that wide? i.e. if the RBA puts the rate up by .25 points will the assessment rate used by the banks follow and rise to 7.5%? Or is the assessment rate more focused on targeting the average rate over time?

    I'm wondering: if as interests rates rise to what extent will the banks assessment rate rise? I'm also wondering, if interest rates rise and yields rise with this and the assessment rate remains the same or does not move as in conjunction with the cash rate, will we see a return to an environment where credit is easier to access?

    Perhaps I'm being too hopeful.

    Also, apologies if this has been posted in the wrong area, the finance section wouldn't load for me.
     
  2. euro73

    euro73 Well-Known Member Business Member

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    It has been applied at a 7% P&I minimum. Thats APRA's preferred level. Most lenders have gone a little harder. Its not about a spread. ie 5.5% above the 1.5% RBA cash rate. Its about an assessment rate that reflects historically "normal" rate settings.

    It's actually really all about reducing Debt to Income Ratios- even if they dont say so.

    But in the end, does it really matter? Unless you see large wage increases or rental inflation, the 7.25% P&I assessment rate used by most banks is still a killer for borrowing capacity everywhere...... whether the rate you actually pay goes up or down. It, plus the CPI indexed HEM's have combined to effectively be @ the same as a 65-85K pay cut per Million Dollars of debt.

    I dont think there's any need for APRA to make it a floating buffer. Its clearly working very effectively at its current levels. Borrowing Capacity is now by far the most talked about subject for investors everywhere ....
     
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  3. Redom

    Redom Mortgage Broker Business Plus Member

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    A bit of background to this - this is one of the key backstops to prudential lending in Aus. Its really the key 'buffers' thats inbuilt into serviceability models. In many cases, its the only buffer in built (i.e. buffers not applied to expenses, many forms of income, etc). I believe a while ago (<2014), the prudential practice guideline didn't have a clear floor rate on debt (at least not OFI debt) that lenders must use. It was a little bit more open to interpretation and was more along the lines of 'lenders should sensitise debts at a min of 2% above repayment'. They then made this clearer and added in the floor rate to avoid any uncertainty.

    If rates did fall to zero, i don't think they'll change this floor rate and lenders will need to stick to it. There may be marginal falls down to 7%, but i doubt it'll fall below this as its prescribed in the prudential practice guide that lenders need to stick to.

    This adjustment in policy means that the transmission mechanism of reducing interest rates and putting a rocket under borrowing capacities has been significantly weakened.

    It will definitely increase the demand for credit (price drop), but it will only have marginal impacts on borrowing capacities. In terms of prudent fin stability, thats how it should work. Having prudent lending policies is arguably more important in an environment of rapid credit growth and cheap credit, than in slower credit growth environments. Usually fin stability issues begin with poor credit standards in boom periods.
     
  4. jefn89

    jefn89 Well-Known Member

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    Watch this space for it to get significantly more stringent on documenting and justifying living expenses!
    Credit will likely get harder and then fingers crossed get easier to obtain (can tend to go in cycles) although should hopefully result in a stronger financial system that also balances enabling first home buyers to get into the markets (which is often a very tough balancing act)
     
  5. JohnPropChat

    JohnPropChat Well-Known Member

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    1. Is OFI debt assessed at 7.25% P+I as well?
    2. Is the rate applied on outstanding debt in combination with time left(let's say 20 years) on the mortgage? If so wouldn't simply refinancing to a new 30-year loan before buying the next IP increase overall serviceability?
     
  6. Rolf Latham

    Rolf Latham Inciteful (sic) Staff Member Business Plus Member

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    APG 223

    End of story

    ta

    rolf
     
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  7. datto

    datto Well-Known Member

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    How come they don't crack down on credit card limits? A while back I had 100K limit and the banks kept sending me letters to increase.

    The way they were going I could practically by an IP on visa. I have got rid of most of my cards. It was just too tempting to go and buy a Club Sport on tick.
     
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  8. paulF

    paulF Well-Known Member

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    RBA weighs alternatives to a cut

    "Industry participants believe the central bank and banking regulator are considering a targeted alternative to a cut to the official cash rate, which would involve lowering the minimum 7.25 per cent interest rate banks use when assessing a home loan borrower’s repayment capacity by 50 basis points to 6.75 per cent.
    "
    RBA weighs alternatives to a cut

    I think a few on here were talking about the possibility of the above ...

    PS: disable javascript to read the article
     
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  9. Lacrim

    Lacrim Well-Known Member

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    What was the typical assessment rate in the good ol' days before the APRA mandate ie pre late 2017?
     
  10. Peter_Tersteeg

    Peter_Tersteeg Mortgage Broker Business Member

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    For most lenders assessment rates have generally been about 2% higher than the actual rate. For the most part I think actual rates were still above 5% when the mandate was issued, so no real effect.

    ING introduced their 8% floor rate shortly after the GFC. It's what makes them one of the most conservative lenders in the market. When rates are high however, they compare fairly favourably. I suspect it'll be a long time before we see that again.
     
  11. Lacrim

    Lacrim Well-Known Member

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    So if they were assessing loans at 5+2= 7% pre the mandate, what's really changed? Was it the debt to income multiple? If so, do you mind telling us what it was before and after?
     
  12. Peter_Tersteeg

    Peter_Tersteeg Mortgage Broker Business Member

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    For the most part, there wasn't any measurement of income multiples until a few years ago and even today most lenders don't use it. Even when it is used it's rarely the metric that gets a loan knocked back. The 'net surplus' metric kills deals long before income multiples do. This metric is probably more political than practical.

    The other major changes have been made to:
    * Living expenses (minimum figures are now based on income and location, also starting to verify against actual spending patterns)
    * Treatment of existing debts (assessment rates is part of it, but there is more too it)
    * Treatment of regular vs variable income (commissions, bonus, overtime, etc)

    Whilst lenders are saying that they're relaxing their standards, I'm not really seeing it. Lenders are cutting rates, offering incentives and competing for business, but they're not relaxing their actual policies in any significant way. They're keen to get the really good business but this is a continually shrinking slice of the market.
     
    Last edited: 30th Apr, 2019
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  13. euro73

    euro73 Well-Known Member Business Member

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    The assessment rate for “new” money was always buffered - I’ve written about this previously . It means that for first home buyers without other mortgage debt, it’s mainly living expenses that have changed and reduced their borrowing capacity by 15%ish

    It’s the assessment rate for existing or other mortgage debt that’s been the big change on servicing calcs - in other words “actuals” have been replaced by a sensitised/buffered floor rate of 7% P&I . This affects people with existing debt far more than it used to . That , plus the big increase to living expense have combined to reduce investors capacity by close to 50%

    So investors have seen a much larger reduction in borrowing capacity than Owner Occupiers is the general takeaway from the changes .

    The DTI ratios we often talk about on here are not official policies - they are just the unofficial manufactured result of how most lenders calculators now work . I have referred previously to DTIs as being a policy achieved by “stealth” for this reason . But we should be under no illusion - it’s no coincidence that’s where things landed . That’s my view anyway - that APRA designed their intervention around delivering a DTI of @7 x income by stealth. Otherwise it’s a remarkable coincidence that all lenders land in or around that same sort of range :)

    Interestingly , supposedly sophisticated commentators like Christopher Joyce are claiming discussions are underway to reduce the floor rate by 50points from 7.25 to 6.75 ... it would be helpful if he quoted the correct floor rate for starters .:) It’s 7% not 7.25%. 7.25% may be the rate most lenders may have adopted , but the actual floor rate mandated by APRA is 7%. So a reduction to 6.75% would be a 0.25% reduction to the floor rate , rather than a 0.5% reduction
     
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  14. Redom

    Redom Mortgage Broker Business Plus Member

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    For the nerdy ones out there, APG 223 version in 2014 prior to the significant changes to borrowing power didn't explicitly state what a floor assessment rate was (as mentioned above & attached). It noted that the assessment rate should be based on a historical average of long run interest rates and should be reviewed over time. It did note that it should be applied to new and existing debt (clearly some banks didn't follow this properly in 2014).

    If APRA were happy to go back to this particular wording, than banks can reasonably adjust the assessment rate themselves and apply a lower floor (~6.5-6.75% sounds about right). The market would then adjust assessment rates accordingly and there'd likely be an environment where lenders can actually compete on borrowing power again (this largely doesn't hold anymore amongst ADI's).

    My experience working in fin stability at Treasury, tells me that there'd be a pretty big reluctance from the CFR to do this. I may be a bit biased as I've only worked in financial stability regulation and not specifically on monetary policy - but I'd go so far to suggest that they'd actually rather just reduce the cost of debt across the board. Most research suggests that rate cuts are significantly more powerful at driving up demand for housing (even if the transmission mechanism to higher borrowing power is weakened).

    Cutting the assessment rate helps people borrow more.

    But the regulators have looked deeply into this and don't believe the current slowdown in housing is a function of restricted borrowing power (other factors in credit decisioning other than borrowing power, and mainly supply outstripping demand).

    Screenshot 2019-04-30 13.32.37.png
     
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  15. euro73

    euro73 Well-Known Member Business Member

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    This is where - in my view at least - they have their heads a little bit up their you know whats.... and are getting it wrong. They are overestimating the impact of low wage growth and they are also overestimating how much spare capacity is out there, citing the fact that 1/3 of properties are unmortgaged or thereabouts to defend that view, all while underestimating the impact of their regulatory intervention.

    Both those circumstances (low wages and 1/3 of properties being unencumbered) existed for a long time before APG 223 was a twinkle in APRA's eye , and both were having zero impact on price acceleration. They werent even a feather on the brakes. The reason why is very simple. "Actuals" rendered the anemic wage inflation completely redundant because the big rate cuts earlier this decade provided the equivalent of massive wage growth on servicing calcs instead .


    So in my view ( and it needn't be anyone else's) , this is leading our regulators to underestimate the impact of what their policy settings in contributing to the correction. It's surprising really, given how obvious it is. I mean, APG 223 happened because actuals were having this effect , and the correction started almost immediately following APG 223 being introduced, and has steadily accelerated as pre regulation loans and borrowers rolled out of old rules into APG 233 rules... It's not like prices slowed to a steady crawl, then started retreating slowly. It was literally - rules have changed. brakes were tapped and within just a few months, auction clearance rates plummeted and prices started correcting. No slowing. Correcting. And for 2 years +, they have kept correcting. Rates didnt go up. Unemployment didnt blow out. Massive infrastructure spends started. Yet prices kept correcting. I don't see how there can be any ambiguity in connecting those dots. Yet they would have us believe that it isn't their targeted, pinpointed , deliberate intervention that has created this correction......

    Now, I understand the correction wasn't their aim. I get that. They wanted to force a migration to P&I and force debt to start being paid down.. House prices arent APRA's concern at all....never have been. I doubt they even considered /anticipated this would happen this quickly. But unintentional or not, house prices have certainly been the consequence and the sooner they and the RBA stop pretending a little wage growth will fix it, the better. It wont do the trick.

    Here's another way to view it- does anyone really believe that a 25 or 50bpt reduction would arrest the decline? I mean, that's going to inject extra income to households, right? Just like wage growth might... Cos thats basically their argument, that a little extra cash in households will be the fairy dust that comes along and gets people spending again....

    Me neither... at least not enough to get people out buying new cars and spending on retail and so on and so forth ... :) And even if they did produce those results , do we want the RBA using up the last of its reserves when there’s another way to achieve that? They need to consider a re-think, methinks. Perhaps a little of both rather than all of one or the other ....
     
    Last edited: 1st May, 2019
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  16. JohnPropChat

    JohnPropChat Well-Known Member

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    While cheap credit and foreign money played a major role during the boom, the fact that we used up all the cheap credit and struggling to cope with even a 20% to 30% correction is a sign that many over extended. As much as it pains me to see my borrowing capacity go down the drain, I for one am glad for the macro prudential measures.

    In my opinion, we should let the correction run its course. Let FHBs have a breather and jump on the bandwagon. Large developers will slowly clear out and supply will tighten over time.

    Unmaintainable growth followed by a recession is much worse than steady correction with short term pain.
     
  17. Blueskies

    Blueskies Well-Known Member

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    Where there's smoke theres fire. I think odds are this or something like it will happen within the next few months, especially if house prices keep falling along with weak gdp/inflation numbers.

    Kinda feel sorry for the RBA. APRA get their house in order by turning the credit taps down and RBA get the job of trying to fix the flow on effects to the wider economy.
     
  18. Rolf Latham

    Rolf Latham Inciteful (sic) Staff Member Business Plus Member

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    Japan being proof of your theory I guess ?

    ta
    rolf
     
  19. JohnPropChat

    JohnPropChat Well-Known Member

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    No theory, just an opinion.
     
  20. Rex

    Rex Well-Known Member

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    I don't think there are many people out there standing on the sidelines, deciding not to buy property because they think current interest rates on offer are too expensive. A 25 or 50 point drop to interest rates will have very minimal impact on the housing market at this point. We are reaching the boundary conditions of monetary policy (not that monetary policy aims to stabilise housing markets).