A decade of regulatory reforms has forced many buyers out of the market, an economist says

Australia's aim to achieve a "strong" financial system has hindered many would-be buyers from breaking into the housing market, says an economist.

Tim Reardon, chief economist at the Housing Industry Association, said the decade of reforms since the global financial crisis has been forcing first-home buyers out of the market, contributing a decline in homeownership. He said the collapse of financial institutions during the GFC had compelled Australia to review the regulatory landscape of the banking sector.

"Since this time, the treasury and other regulatory agencies have been working to reduce the risk of residential mortgage business within the banks for fear that they may once again be required to assume the banks' risk," he said.

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What are some of the changes?

To help the banking sector be "unquestionably strong", the government and regulators adopted a "belt and braces" approach. Since residential mortgages were deemed riskier than they had been considered prior to the GFC, mortgage lending became more capital-intensive.

Furthermore, financial institutions started pricing in additional costs through higher borrowing charges. These are being applied to riskier types of loans, including interest-only loans to investors, loans with high loan-to-value ratios (LVRs), and loans in riskier geographic areas.

The Australian Prudential Regulation Authority (APRA) also revisited the guidelines for residential mortgage lending three times since 2014. Reardon said the guidelines in the 2019 version are "considerably more stringent" than the guide that existed before 2014.

"Banks must now apply much greater scrutiny on the income and living expenses of applicants. There are tighter criteria for assessing loan serviceability buffers and lenders are required to discount non-salary income when establishing an applicant's income," Reardon said. "There are more restrictive criteria for assessing applications for interest-only loans, and guidelines were added for mortgage lending to self-managed super funds."

When the housing market started heating up between 2014 to 2017, investor and interest-only lending surged at a rate beyond the comfortability of regulators. This had resulted in a series of tightening, including a 10% cap on investor credit growth and interest-only lending. These limitations were withdrawn eventually.

Banks looking for high-quality borrowers

Reardon believes that while banks claim that they are "open for business", they have narrowed down the criteria for a would-be borrower to be considered as "high quality", making it more difficult for many to obtain housing finance than it was prior to 2014.

"The problem is that in the pursuit of this 'unquestionably strong' financial system, the regulatory squeeze has forced the banking sector to eliminate much of the flexibility in the mortgage market that made homeownership accessible for households of variable credit quality," Reardon said.

In fact, loans to home buyers with LVRs over 90% now account for only 7% of new loans. In 2009, such loans made up 20% of new lending.

"The high point in 2009 coincides with the boom in first home buyer activity in response to the GFC stimulus measures. The ability to access finance with a high LVR was a factor that assisted many first-home buyers to enter the market," Reardon said.

The federal government has rolled out several initiatives to help boost participation of new buyers in the market. The First Home Loan Deposit Scheme (FHLDS), for instance, aims to help eligible borrowers break into the market  with as little as 5% deposit.

"Ensuring that homeownership remains an attainable aspiration for Australian households is an equally important objective,” Reardon said.