Unintended consequences for borrowers

The Australian Prudential Regulation Authority (APRA), has made a simple, but significant change to the lending rules for banks and other authorised lenders. This could well lead to some unintended consequences.

From November, borrowers seeking housing finance will need to demonstrate that they are able to meet repayments when interest rates are assessed at least 3 per cent higher than the actual loan interest rate applied to their loan.

This assessed rate, also called the buffer, floor or repayment serviceability rate, was reduced to 2.5 per cent above the standard variable rate when it became apparent that we were not going into a recession as a result of the pandemic.

The issue is that the provision of housing finance is a complicated process, because it needs to balance the risks to lenders of providing huge amounts of money against the opportunities that housing finance provides to home buyers and investors.

The history of broad brush interventions in such complex systems, no matter how well intentioned, shows us that there will always be some unanticipated and even undesirable results. We may be about to see some of these unexpected outcomes in coming months.


Moving from lower to higher floor rates in just one year

Before the recent APRA change, the low floor rate was one of the main drivers of the housing boom, because it enabled more first home buyers to enter the market. At the same time the lower floor rate has given all property buyers, including upgraders and investors, access to higher amounts of housing finance.

The lower floor rate had the same effect as a cut in interest rates of about two percent, and in my blog The property market stripped bare in March this year, I predicted that this could lead to an average rise in housing prices of 25 per cent above pre-pandemic levels.

The increase in the floor rate will now reduce the potential for housing prices to rise nationally by 20 per cent over pre-pandemic levels, which is where the market was poised as at the end of September. This slowing down of buyer demand is the aim of APRA’s change to the floor rate. But what of the unintended consequences?

Existing home owners will find it harder to refinance or move

APRA’s change will tie many existing home owners to their current mortgages, because their future loan repayment serviceability will be assessed at the new, higher floor rate.

They will find it more difficult to “shop around” for a better deal, use their equity for renovations or even to relocate in future.    

First home buyer demand will move, rather than reduce

Many potential first home buyers will simply shift their search for areas where housing prices are more affordable. While this will reduce demand in the most expensive first home buyer locations, it will also drive up demand in lower priced suburbs and more less costly types of housing until the new floor rate borrowing limits are reached.

So, rather than reducing overall home buyer demand, the rise in the floor rate will merely push first home buyers into more affordable locations and types of properties,  while tying many existing home owners to their current mortgages.