Some buyers caught out at settlement as borrowing power tumbles

Homebuyers caught out by the sheer size and speed of interest rate rises could be left scrambling to come up with additional funds before settlement – or potentially risk losing their house deposit.

Rapidly rising rates have wiped tens of thousands of dollars off the maximum borrowing capacity for a typical buyer since May, prompting fears some may get caught out when they reach settlement.

That’s because most lenders won’t honour the pre-approved assessment rate if interest rates rise, according to Mortgage Choice broker James Algar.

“If you’re pre-approved today and next week the Reserve Bank of Australia puts the rate up, when the bank passes through that rate rise your pre-approval will be worth less,” Mr Algar told realestate.com.au.

“Until that final approval is issued, it’s all potentially up for negotiation by the banks.”

Given interest rates are rising so fast, buyers who are borrowing at or near their maximum capacity have little wriggle room to take on a larger loan, meaning the funds will need to come from elsewhere.

How far borrowing power has fallen

As a general rule of thumb, a typical buyer’s borrowing capacity drops by roughly 5% each time the RBA increases the cash rate by 50 basis points – assuming a lender passes on the hike in full.

Since May, the RBA has taken the cash rate from 0.1% to 2.35%, with a further 50 basis point increase expected when it meets next week.

So far, PropTrack senior economist Eleanor Creagh estimates maximum borrowing capacities have already dropped by about 20%.

“And if the cash rate reaches 3% – as the RBA has alluded to in speeches and forecasts – maximum borrowing capacities will be reduced by close to 30%,” Ms Creagh said.

For many borrowers, that equates to tens or even hundreds of thousands of dollars in reduced borrowing power, Mr Algar said.

“In April, we did a pre-approval for a client and their maximum borrowing power at that point was $990,000 as a couple,” he explained.

“When that pre-approval expired, we renewed it in August and their maximum borrowing power was $855,000,” he said.

“By Christmas, even without another rate rise, their borrowing capacity would be down to $820,000. Another rate rise could quite easily push that down to potentially $800,000 or less.”

Calls to lower the home loan stress test

Banks are required to add a buffer when assessing new loan applications to ensure borrowers would still be able to meet their repayments on an interest rate at least 3% higher than their initial rate.

This was increased from 2.5% last October by the Australian Prudential Regulation Authority, which cited concerns that ultra-low interest rates were encouraging borrowers to take on ‘risky’ levels of debt.

On a 4.17% mortgage rate, that means the lender would assess a borrower’s ability to service that loan if rates rose to at least 7.17%.

Ben Kingsley, managing director of Empower Wealth and Chair of the Property Investors Council of Australia, said that elevated level is no longer appropriate and needs to be lowered.

“It’s incredibly surprising that they haven’t acted on this already,” Mr Kingsley told realestate.com.au.

“We saw the regulators over in the UK act diligently to reduce their buffer rates in August, and we sit here at the end of September with APRA’s buffer rate still sitting at 3%, and that is ultimately having a direct impact on borrowers who are either trying to purchase or are stuck in mortgage jail because they can’t refinance to potentially a better deal.”

He said the immediate risks were already playing out for buyers relying on their loan pre-approval.

“We’ve definitely got examples in real time where we’ve got lenders who are dishonouring pre-approvals, as well as others who are honouring the 90-day period in which those pre-approvals were originally assessed,” Mr Kingsley said.

“We have evidence of people having to find extra cash to complete those settlements.

“[The risk is] they’re unable to settle which, worst case scenario, could mean that they lose their deposit, which would be a horrible outcome for those people who have worked really hard to save up that money for the deposit.

“So they are real and active situations right now that we’re seeing in the marketplace.”

The buyers most at risk

Once a property sale becomes unconditional, buyers are legally obligated to follow through with the sale, or risk losing their home deposit if they can’t get the finance.

Mr Algar outlined three groups of buyers most at risk.

They are those who don’t check if their loan pre-approval is still valid before purchasing a property, those who purchase at or near their maximum borrowing capacity, and those who opt for a long settlement.

“If they’ve agreed to a long settlement because maybe they are waiting to sell their house or they’ve got some money coming to them, or they’re just looking to save the balance of their deposit, in that time they might well have had a significant fall off in their borrowing power and they’re going to be in trouble,” Mr Algar said.

“Once you’ve actually got a full loan approval, with most banks you’ve got at least three months or possibly six months to settle before that loan offer expires and they revisit it,” he said.

“So if you’ve got a long settlement make sure you get your loan formally approved as quickly as possible with a lender who’s got a long settlement acceptance.”

He said borrowers concerned about falling borrowing capacity could consider getting a pre-approval through a lender that will honour that amount until the 90 day term expires.

“There is a handful of lenders who are willing to honour the assessment rate at the time of pre-approval,” he said.

“If you haven’t spoken to a mortgage broker in a month, or double checked your figures within a month, there’s definitely been a rate rise in that time,” he said.

“You’ve just got to stay engaged with your broker all the way through and not just assume that you’re good for 90 days.”

And for those who were initially priced out of the market but are now seeing value, Mr Algar said it’s potentially more bad news.

“They’ve now found a property they’re happy to pay for, but the bank won’t lend them enough to close it off,” he said.

“There’s a lot of that, people coming out of the woodwork and thinking great, there’s some value now I’m happy to pay that, but they can’t afford to pay that now.”

Resource: REA