RBA flags risks of excessive mortgage borrowing

The Reserve Bank of Australia has signalled potential risks of Australian borrowers' "exuberance" amid the current housing market conditions.

According to the RBA's latest Financial Stability Review (FSR), low interest rates have contributed to high house prices.

"Vulnerabilities can increase if housing market strength turns to exuberance with borrowers taking on greater risk given expectations of further price rises and banks potentially easing lending standards," the report said.

However, the Australian Prudential Regulation Authority (APRA) has already started to address the risks.

The regulator has recently updated its mortgage macroprudential policy (MPP), increasing the interest rate buffer to 3 percentage points (pps).

How does Australia's macroprudential policy compare to other advanced economies?

The RBA said macroprudential policies have grown in prominence since the global financial crisis.

"This reflects the extended periods of low interest rates in a number of countries to stimulate economic activity, which has boosted activity in housing markets and in some cases has been associated with excessive risk-taking," it said.

The RBA said Australia and other advanced economies have employed different measures to ease lending.

These measures are often based on the structures of housing and lending markets, implementation costs, competition concerns, and the distributional consequences for borrowers.

The most common MPP used internationally include restrictions on serviceability, debt-to-income (DTI) ratio, and loan-to-value ratio (LVR).

Serviceability restrictions

Restrictions on serviceability are used to constrain lending to borrowers who would have limited income left after meeting basic living expenses and servicing their debt.

Serviceability restrictions work by adjusting requirements for the interest rates used by lenders to calculate maximum loan sizes.

These restrictions include setting up interest rate buffers and floors and limiting debt-servicing costs relative to income.

An example is APRA's recent move to increase the interest-rate buffer, which is likely to reduce the maximum borrowing capacity by 5%.

These measures will ensure that borrowers will still be able to service their debts even in the event of a hike in interest rates.

DTI ratio restrictions

These restrictions limit the maximum amount households can borrow relative to their incomes.

For new borrowers, these restrictions will cap their debt-servicing costs, ensuring that they have larger cash buffers when they take out their loan.

Regulators in the United Kingdom and Ireland have implemented restrictions on high DTI ratios for owner occupiers.

LVR restrictions

LVR restrictions limit the amount that can be borrowed relative to the value of the property.

This MPP constrains the supply of credit to borrowers with low equity.

LVR restrictions have been used in a range of countries, given that it directly targets specific risks.

In New Zealand, LVR restrictions are set at 60% for investors and 80% for owner-occupiers.

Sweden has an LVR restriction of 85% for both owner-occupier and investors.

Will APRA's new rules make a difference?

Your Mortgage home loan specialist Raj Ladher said APRA's recent move would likely have "little impact" on owner-occupiers.

"This change will impact investors more due to investor rates being higher. I believe this is what the regulators are trying to curb to begin with,” he said.

REA Group economist Angus Moore shared similar insights, adding that the impact of the move on individual borrowers depend on two things.

"The change only reduces maximum borrowing capacity. Not everyone borrows the maximum that they could," he said.

Citing data from CBA, Mr Moore said only around 8% of borrowers borrow at maximum capacity.

"Any borrowers who would have previously been just shy of their maximum will be on or above their maximum borrowing capacity under the changes," he said.

The second factor would be on how high the interest rates are.

Mr Moore said lenders working with the changes in serviceability rules will either assess borrowers with an interest rate that is 3 pps higher or using the floor rate, which is currently around 5%.

"This floor means that the new higher buffer only affects new borrowers whose mortgage interest rates are above roughly 2% — depending on the floor the lender uses," he said.

"It also means the change will have a bigger effect on borrowers whose interest rates are higher than 2.5% than those whose rates would be between 2% and 2.5%,"

APRA’s recent move, however, was just the start. The regulator recently indicated that it will publish later this year an information paper outlining its holistic framework for macroprudential policy, not just for mortgages.

“With all these official publications about measures and how to implement them, it seems very likely that further changes are coming to curb lending that the regulator views as risky,” Mr Moore said.