No matter how low interest rates may fall, banks should make sure new borrowers can repay their debts with mortgage rates of at least 7 per cent, new guidelines have confirmed.
The guidance, already widely followed across the industry, was formally adopted in a new policy that entrenches tougher rules on bank mortgage lending from the Australian Prudential Regulation Authority.
After recent signs of a resurgent property market in Sydney and Melbourne, the regulator also locked in various policies that it hopes will make sure banks are realistic in assessing borrowers’ ability to repay their loans.
APRA on Monday updated its industry guidance to ensure banks are “prudent” in managing risks in the $1.5 trillion mortgage market, which accounts for about 60 per cent of domestic banks’ loans.
In a key change, APRA is now being more specific in demanding minimum interest rates banks must use when approving customers for home loans.
Banks advertise interest rates well below 4 per cent for new customers but APRA said a “prudent” bank would have an assessment rate of at least 7 per cent.
It also said banks should make sure a potential customer would still be able to repay their loan if interest rates rose 2 percentage points – previously it had not specified how big such a buffer should be.
Banks already satisfy many of these guidelines after a crackdown over the last two years, but the regulator aims to make sure lending standards are not eroded away in the future by competition, as has occurred in the past.
Some banks were assuming borrowers had unrealistically low living expenses. APRA is seeking to address this by saying banks cannot only rely on indexes of living expenses, and must “scale” these indexes according to a borrower’s income.
For instance, it says that even if a borrower does not have housing costs because they live with their parents, banks should still make a “reasonable estimate” of what their housing costs would be if they had to pay for housing.
The policy also specifies the minimum “haircuts” banks should make to non-salary income. It says banks should apply a haircut of at least 20 per cent to non-salary forms of income – including bonuses, overtime, or rent from investment properties – when they are assessing a loan application.
It also told banks to take extra care with the risks in lending to self-managed superannuation funds investing in real estate.
The toughened guidelines come after APRA chairman Wayne Byres last year bemoaned the “horribly” low quality of some lending last year, though more recently the regulator says standards have improved.
“While the quality of loan underwriting in the residential mortgage lending market has improved, APRA is continuing to maintain its close monitoring of investor lending and other areas that may contribute to risks in the housing lending market,” APRA said in a letter to banks.