An expected interest rate cut on Tuesday could add tens of thousands of dollars to an average buyer’s borrowing capacity, but one simple policy tweak could give them an even greater leg-up.
Known as the ‘buffer rate’, lenders are required to apply a serviceability buffer on top of the interest rate when assessing a borrower’s ability to repay a home loan.
The buffer rate was increased from 2.5% to 3% in 2021 when record low interest rates spurred on a borrowing frenzy. But the 3% mortgage serviceability buffer asks a lot of home loan borrowers amid very high property prices.
After reviewing the rate in July, the Australian Prudential Regulation Association (APRA) decided to hold at that mark due to high levels of household debt and above-average total credit growth. Furthermore, the risk of economic shocks from global events is also elevated and so the thinking is that it’s best to keep things as they are.
Many in the industry see the logic behind this, while others argue that home buying is being made even harder for younger Aussies.
Consider that on a 5% variable rate home loan offered by some banks at present, the borrower’s ability to make repayments is assessed at an interest rate of 8%.
APRA has decided to leave the 3% mortgage serviceability buffer as is. Picture: Getty
REA Group senior economist Eleanor Creagh says that while the buffer is an important safeguard for borrowers, it’s also a constraint on would-be buyers in the current market.
She highlights that affordability pressures are only worsening given limited housing supply and increasing population growth.
“Further interest rate cuts are expected later this year which will ease borrowing costs, but add to the momentum in housing demand and reinforce recent price growth,” Ms Creagh said.
PropTrack’s latest Home Price Index shows national property prices reached an all time high in July, with a median home now costing $827,000.
The $36,000 boost to borrowing power
Analysis by Mortgage Choice has revealed a 0.25% reduction in the cash rate would improve an average household’s borrowing power by tens of thousands of dollars.
A family able to borrow the average loan size of $660,000 would see that rise to $678,000 with a 0.25% rate cut, an improvement of $18,000. This assumes a starting interest rate of 6.01%, and that their lender passes on the rate cut in full.
But reducing the buffer rate back to 2.5% would have an even greater impact, with a 0.5% lower serviceability buffer rate adding $36,000 to a family’s borrowing power.
Lowering the serviceability buffer could significantly improve borrowing power for an average household. Picture: Getty
Mortgage Choice broker Terri Unwin says there are indeed a range of factors that impact borrowers getting a home loan, not just the buffer, including the information they provide about living expenses and handling regular repayments.
“I don’t think the serviceability buffer is necessarily a bad thing,” Unwin said. “It does provide protection to both the customer and lender to ensure the loan is going to be affordable.
“But 3% is a bit high in a no-panic interest rate environment. In a stabilised economy like now, I think 2.5% is a reasonable buffer.”
With interest rates expected to decline over the next 12 to 18 months, buyer’s agent Pete Wargent told realestate.com.au the 3% buffer makes little sense.
“2% would be fine. In 2019 and before, mortgages were typically stress-tested to ensure borrowers could comfortably absorb a 2 percentage point increase,” Mr Wargent said.
“But lending standards have continued to tighten, which is an ongoing trend over the past dozen years.”
APRA chair John Lonsdale says the current level of the buffer has not been restrictive on new credit to households, but Mr Wargent says he’s seen plenty of first time buyers unable to borrow because of the current serviceability constraints.
APRA chair John Lonsdale. Picture: Chris Pavlich/The Australian
Peter White, managing director of the Finance Brokers Association of Australia (FBAA), also disputes this claim.
Mr White said research commissioned by the FBAA found that a 0.5% reduction of the buffer rate would mean that around 270,000 more people could access median home loans.
“This small reduction would unlock loans for borrowers we know can afford to service them,” he said.
“Our research has found reducing the serviceability buffer by 0.5% could boost borrowing capacity by $276 billion nationally.
“In the light of all this, it’s very difficult to accept APRA’s claim that credit continues to flow where it’s needed.”
Borrowing power has been squeezed by higher interest rates and rising property prices. Picture: Getty
He said the 3% buffer was also forcing thousands of Australians to remain in ‘mortgage prison’, unable to refinance loans for a lower rate, “despite them having proven their ability to service a loan at a higher rate”.
The term ‘mortgage prison’ hit the headlines when rapidly rising interest rates during 2022 and 2023 meant many homeowners no longer qualified for the loan they took out when rates were at record lows.
Ms Unwin says there needs to be a happy medium between protecting first-home buyers and giving them an opportunity to get the property they want.
“I say to a lot of my first homebuyers, it’s one thing for the bank to say you can borrow $1.2m, but work out what you’re comfortable with,” she said.
“Set your maximum loan amount because you still have to live and enjoy yourself.”
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