Regulators hint at tighter lending restrictions as ‘risky’ home loans rise

Financial regulators have signalled further curbs on lending activity could be on the way as one-in-four mortgage borrowers take on ‘risky’ levels of debt.

In a statement on Wednesday, Australia’s Council of Financial Regulators said an increase in the share of home loans with a high debt-to-income ratio had been a key focus of discussion at its quarterly meeting last week, particularly with a looming Reserve Bank interest rate hike expected to drive up mortgage repayments.

“It is important that lending standards are maintained and that borrowers have adequate buffers,” the council said.

“Especially in an environment in which housing loan interest rates are at historically low levels and are expected to rise over time in line with the economic recovery.”

The council, which is chaired by RBA governor Philip Lowe and includes the Australian Prudential Regulation Authority (APRA), the Australian Securities and Investments Commission (ASIC) and the federal Treasury, signalled high-debt borrowers could be targeted.

“A particular focus of the discussion was the increased share of loans with a high debt-to-income (DTI) ratio,” the council said.

Recent figures by the banking regulator APRA showed one in four (24.4%) residential home loans settled in the three months to December had a debt-to-income ratio of six or greater, up from 23.8% the previous quarter, and 17.3% a year earlier.

Borrowers who take on a mortgage at least six times their pre-tax income are considered to be in a higher-risk lending category.

“Members discussed the actions being taken by banks to manage the risks within their portfolios, and will continue to assess the need for further macroprudential measures,” the council said.

One of the obvious reasons borrowers have been taking on more debt is that the cost of borrowing remains at or near record lows, PropTrack economist Angus Moore said.

“High debt-to-income loans are a direct result of low interest rates,” Mr Moore said. “Falling interest rates increase house prices, which increases the size of loans people take out.”

He said a framework paper released in November by APRA detailing macroprudential policy options, and now Wednesday’s statement, indicated further measures would be brought in at some point.

“I think there’s a chance we’ll see further macroprudential changes this year,” he said.

What measures could we see?

APRA has already moved to mitigate lending risks by imposing higher serviceability buffers on all new loan applications, which came into effect in November last year.

It means lenders must assess whether an applicant would be able to meet their loan repayments if interest rates increased by at least 3%. Before then, the minimum buffer had been 2.5%.

Those measure impacted all borrowers by reducing how much they could borrow. APRA estimates the measured reduced the maximum borrowing capacity for a typical borrower by around 5%.

ANZ senior economist Adelaide Timbrell said those measures combined with rising interest rates would cool lending demand in the months ahead, with any additional measures from regulators likely to be more targeted.

“We expect that higher serviceability buffers and higher interest rates will drive down housing finance over coming months,” Ms Timbrell said.

“While it’s still possible that APRA steps in with further measures, we expect them to be quite narrowly focussed on loans that are both high debt-to-income and high loan-to-valuation.

“If, however, housing finance proves to be more resilient than we expect as interest rates rise, we may see broader measures, such as another increase in the serviceability buffer.”

Despite high levels of household debt, Ms Timbrell said most households were in a good position to withstand higher rates.

“While there are always going to be some households who could become financially vulnerable as the cost of living and interest rates increase, for the most part Australian households are very well placed to withstand rate increases,” she said.

“Strong savings buffers, tighter lending regulations and our expectation that wages will increase materially in the next 24 months all work together to reduce the risk of financial instability as a result of rate increases.”

High-debt loans not indicative of mortgage defaults
While the proportion of borrowers taking out high-debt loans has been on the rise, Mr Moore said it won’t necessarily result in more mortgage defaults.

“High debt-to-income doesn’t show the full picture of risks in the market,” Mr Moore said.

“When we look at measures of serviceability, for example, repayments on a typical new mortgage adjusted for inflation, these remain pretty good, even with the steep run up in house prices.”

He said other measures of asset quality also remain strong, with a decline in the number of loans going into arrears or becoming non-performing over the past year for both investors and owner-occupiers.

“It’s always important for regulators to be monitoring risks,” he said.

“Focusing solely on high debt-to-income lending would provide a too narrow and potentially misleading view, which is why we look at a range of measures.”

Resource: realestate.com.au