APRA Increases interest rate buffer
Last week we reported that the Australian Prudential Regulation Authority (APRA) and the Reserve Bank of Australia were looking to tighten lending standards due to the rapid increase in property prices. We anticipated the tightening would not be focused on investor lending, rather the focus would be on the income to loan ratio. This week, the APRA informed the banks they would require borrowers to increase the interest rate buffer from 2.5 to 3.0 percentage points. This means the borrower must have an income that can serve the loan application if the interest rate was 3.0 percentage points higher than the current rate.
This buffer is designed for two purposes. Firstly, if the borrower’s income is reduced or expenses increase, they should theoretically still be able to service the loan. Secondly, when interest rates do eventually rise, the risk of foreclosure is greatly reduced.
There are a few interesting factors here. The increased buffer from 2.5 to 3.0 percentage points feels unlikely to have a major effect on housing prices. It is akin to interest rates rising by 0.5 percentage points which, according to the ARPA, means it should reduce borrower’s maximum capacity by 5%. The table below using median incomes demonstrates the effect.
Based on this table, the increased buffer should have no effect on WA house prices as the new borrowing capacity for median incomes is above WA’s median house price.
However, once international borders open and WA starts to experience the similar levels of overseas migration prior to the pandemic, it is fair to assume house prices will continue to surge. It must be remembered the latest increase in housing prices has come while WA has recorded consecutive quarters of negative overseas migration for the first time since records began. We are still waiting for the Australian Bureau of Statistics (ABS) to release the latest population figures.
Next, due to the level of mortgage and household debt carried in Australia (nearly the highest per capita globally), it is hard to envisage interest rates rising the 3.0 percentage point buffer this generation. The graph below shows the level of housing prices and debt as a ratio of income and makes it is easy to see why interest rates will not return to historical levels.