New buffers a ‘psychological play’: The Property Nerds

Buyer’s agency InvestorKit director and head of research Arjun Paliwal and mortgage brokerage Hills Finance director Leigh Paliwal discussed the changes to mortgage lending rules for lenders introduced by the Australian Prudential Regulation Authority (APRA) in their property and finance podcast, The Property Nerds.

APRA announced in early October that it is increasing the minimum interest rate buffer it expects banks to use when assessing the serviceability of home loan applications from 2.5 percentage points to 3.0 percentage points above the loan product rate (as previously flagged by the Reserve Bank of Australia).

It followed concerns from several quarters about the booming housing market, skyrocketing house prices (amid record low interest rates and the roll-out of government housing grants and incentives), and a rise in high debt-to-income (DTI) lending and increased household debt.

Several lenders (including Bank of Queensland, the Westpac Group, ANZ, and Heritage Group) have commenced applying the new margin.

While economists and the housing industry raised concerns about the ramifications of the changes to home buyers (particularly first home buyers), Mr Paliwal said in the podcast that the changes would not lead to a “seismic shift” in home buyers’ borrowing power.

Mr Paliwal’s assessment was based on a scenario outlined by Ms Paliwal of a married couple, where both partners are earning an average wage of $80,000 each, with a credit card limit of $5,000, $500 per week in rent, in addition to standard monthly living expenses.

According to Ms Paliwal, if the couple chose to purchase an investment property priced at $1 million with a 4 per cent rental yield, that would equate to around $770 per week in rental income, while $500 per week in rent would be incorporated in their standard living expenses because they intend to purchase to invest.

While they could have borrowed just over $1 million under the original 2.5 percentage points buffer, this would reduce to $953,000 under the new 3.0 percentage points buffer.

“It’s about a $53,000 difference, which is 5.0 per cent of the lending requested for in that scenario,” Ms Paliwal said.

For owner-occupiers, the borrowing capacity would have reduced from around $1.187 million with a 2.5 percentage point buffer to $1.137 million under the new 3.0 percentage point buffer.

Responding to the scenario, Mr Paliwal suggested that this did not represent a significant shift, and that the intention of APRA’s changes to the interest rate buffer was “more a psychological shift” rather than “an actual substantial risk reduction”.

Ms Paliwal agreed that the buffer change would not significantly decrease borrowing capacity, and noted that APRA’s aim was to slow a hot property market and prevent the building up of future risk.

She also flagged that APRA could announce additional changes to prevent risk in the market.

“We’re not sure but it’s definitely a psychological thing… they’re starting to slowly taper it back,” she said.

More than meets the eye in buffer change, says fintech

On the other hand, Godfrey Dinh, the founder and chief executive of Futurerent – a Sydney-based fintech that provides property investors up to $100,000 in rental income in advance – warned that his analysis has shown that in practice, “there’s more to the 3.0 percentage point serviceability buffer than meets the eye”, particularly for the 2.2 million property investors in Australia.

The fintech’s calculations showed that for an average family who owns their own home and one investment property, their maximum borrowing capacity could fall by $84,869 – or 11.8 per cent – compared with the 2.5 percentage point buffer.

For a family who owns their own home and two investment properties, borrowing capacity could reduce by 16.32 per cent – or $92,505.

Mr Dinh said: “By making it tougher for people to access financing, these changes will further entrench the disparity between those who already have property and finance, and those who are still in the wealth creation stage of their lives.

“By changing the goal posts again, the banks are knocking back responsible borrowers for loans they can actually afford, and, in many cases, this is actually costing borrowers real money.

“Timing is everything and there are real costs to delaying your property purchase plans because of the new stricter stress test.”

[Related: RBA unwavering on monetary targets]