The Australian Prudential Regulation Authority (APRA) has announced changes to how banks and lenders assess home loan applications. The changes specifically relate to the way lenders assess how much you can borrow for your home loan. The changes mean more people could access home loans and your borrowing power could very likely to increase. This is great news for borrowers. Let’s take a look at what the changes are, why APRA has decided to make them and most importantly, what the changes could mean for you.
How were home loan applications assessed prior to the changes announced by APRA?
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.
Meet Frank. He's applying for a home loan with a 3.55% interest rate. When the lender tests his ability to repay the loan, they don’t actually calculate the repayments at the 3.55% interest rate. They test it at a higher interest rate. This creates a buffer to ensure that if interest rates rise, Frank will still be able to make his loan repayments.
Previously, APRA’s serviceability guidance was that banks and lenders needed 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/assessment rate). The bank/lender had to test the repayments against whichever was highest out of the two options (2% buffer or 7% interest rate floor/assessment rate). APRA’s serviceability guidance also indicated that a prudent bank/lender should use rates comfortably above these requirements, most banks/lenders used a 7.25 % interest rate floor and a 2.25% buffer.
So, if we go back to Frank's home loan application:
He's applying for a home loan with an interest rate of 3.55%. Previously, when the bank/lender assessed his ability to repay the loan they tested 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 changes to guidance around mortgage lending?
Under the new changes, bank/lenders are allowed to review and set their own minimum interest rate floor when assessing home loans, incorporating an interest rate buffer of 2.5% over the loan’s interest rate. The Prudential Practice Guide APG 223 Residential Mortgage Lending, in which the serviceability guidance appears has been amended to reflect these changes.
Why has APRA made 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 changes mean for you?
The changes will likely increase your borrowing potential and give more people access to home loans. Lowering the interest rate floor by even 2% could take off approximately $120 per week of the assessed repayment on a $400,000, 30-year loan.
Let’s see how the changes would affect Frank’s home loan application:
Frank has a base income of $100,000 and $15,000 credit card. He would be able to borrow up to $108,000 more if their loan was assessed at 6.00% 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?
APRA has advised that the new guidance was to take effect immediately upon its announcement (on July 5). However it will take some time for banks and lenders to implement these changes. Some banks/lenders have already made the above changes. If you want to see whether you can benefit from the recent changes, please feel free to contact me and I’ll be more than happy to assist.
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