Lending Rules

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EXPERT INSIGHT

New data suggests changes to mortgage lending rules in the near future are unlikely, despite rapidly rising home values. Recent data from the Australian Prudential Regulation Authority (APRA) suggests that while the proportion of loan originations that could be ‘higher risk’ showed a slight increase through the December quarter, the regulator saw no evidence of a “material relaxation in lending standards”.

Indicators of lending standards are being watched carefully. Borrowing for the purchase of residential property hit a record $28.8 billion in January 2021, up 34.8% from the decade average. This has also contributed to housing values reaching a new record high.

So far however, the December 2020 quarter has not shown any major deterioration in lending standards, suggesting there is no need for interventions in the form of tighter credit policies. The December 2020 quarter is of particular importance, because it marks a positive turn in Sydney and Melbourne dwelling values coming out of COVID-related restrictions.

The share of interest only loans as a portion of new home loans ticked up to 19.2%

The portion of new mortgages lent on interest only terms hit 19.2% in the December 2020 quarter, up from 18.5% in the previous quarter.

This is not far from the 18.7% average seen over the past two years. It is also well below the record high of 45.6%, which was recorded over the June 2015 quarter. However, it is worth noting there have been improvements to collection of banking statistics, and the historic series is not directly comparable with recent data.

Interest only lending was noted as a potential risk to broader financial stability in the years to 2017. At that time, it was becoming more common for borrowers to originate their loans on interest only repayment terms, or refinance and extend their interest only term period. This was leading to a delay in the paying down of loan principals, at a time when house prices and household debt were rising.

Interest only loan structures have generally been more popular among investors, who are eligible for tax deductions on their interest payments. Considering investors remain around record lows as a share of total lending, the risk to financial stability from interest only lending to this segment of the market remains low.

A key area regulators are likely to be watching is the proportion of interest only lending to owner occupiers. The number of interest only loans to owner occupiers increased by 32.5% over the September quarter and comprised a series high 45.7% of interest only loan originations. A sustained lift in owner occupiers not paying down their loan principal, could place upwards pressure on household debt levels, creating stability risks when interest rates eventually rise.

Debt-to-income ratios of greater than, or equal to 6, hit a two year high

APRA has previously cautioned lenders on exposure to loan-to-income ratios, and debt-to-income ratios, exceeding 6. The portion of new home loans originated on a loan-to-income ratio of greater than, or equal to 6 times reached 7.0% of loans over the December 2020 quarter. This is the highest across the series, which commences from March 2019. Loans originated with a debt-to-income ratio of 6 or more made up 17.2% of mortgages originated in the quarter, which was also a series high. APRA did not express concern around this metric in their report, arguing the share of debt-to-income lending was “within its historical average”.

Increased demand across Sydney and Melbourne property markets, as is being seen at the moment, will test debt-to-income ratios. This is because the house price-to-income ratio across Sydney has averaged around 8.5 since 2013, and has averaged 7.5 across Melbourne since 2015. As housing prices rise at a time when incomes are expected to remain relatively flat, there is the potential for both loan-to-income and debt-to-income ratios to lift further, which is likely to be seen as a riskier outcome by regulators.

The proportion of loans originating on high loan-to-value ratios (LVRs) also rose for owner occupiers and investors

<img alt="" height="388" src="https://s3-ap-southeast-2.amazonaws.com/www.urban.com.au/s3fs-public/pictures/article-images/lvr_80.jpg" width="897">

The portion of new home loans originated on a loan-to-value ratio of 80% or more increased to 42.0% across all borrowers in the December 2020 quarter, up from 39.9% in the previous quarter to be the highest proportion on record. The jump was greater the owner occupier space, where 45.7% of loans were originated on an LVR of greater than or equal to 80%, and 14.1% of loans were greater than or equal to 90%.

The regulator argued this increase reflects greater participation of owner occupiers in the market, particularly first home buyers. First home buyers may be accessing housing through loan guarantors, or even the first home loan deposit scheme, which reduced the risk of low-deposit home loans.

The latest data from APRA indicates there is no blow out of risk in mortgage lending, despite the recent surge in property prices across Australia. The publication follows a recent address from RBA governor Phillip Lowe, who reiterated the strategy of maintaining a low cash rate for years to come, which is likely to continue supporting housing demand.

But a deterioration in lending standards can be mitigated, as we’ve witnessed before. This could be achieved by tightening serviceability assessment rates, loan sizes relative to incomes or debt (LTI or DTI ratios) or loan sizes relative to home valuations (LVR). In a recent statement, the Council of Financial Regulators reiterated that while lending standards were generally being maintained at this stage, they have responses up their sleeves if lending conditions do become risky.

While APRA’s December quarter statistics show a trend towards ‘riskier’ styles of lending, the magnitude is not likely to be large enough to trigger a regulatory response; but if this trend continues, or indeed accelerates, it becomes more likely we will see a regulatory intervention aimed at curbing financial stability risks related to the housing sector.
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Housing lending may be cheap, but regulators argue it is not yet risky: CoreLogic's Eliza Owen

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In the first quarter of 2016 the Australian Labor Party (ALP) announced as part of its 'positive policies' manifesto that if elected it planned to wind back certain tax benefits for property investors.  
 
At that point, investor housing finance was down 22 percent year-on-year at just $10.8 billion, following on from APRA's cooling measures. 
 
Predictably enough, since that time, to the extent that at $13.8 billion total monthly investor loans are now 28 percent higher than a year earlier. 
<a href="https://www.propertyobserver.com.au/images/2017/03/14/A1.jpg" target="_blank">Click to enlarge</a>
<img src="https://res.cloudinary.com/dz9xllyip/image/fetch/c_scale,w_580,q_auto:good/https://s3-ap-southeast-2.amazonaws.com/po.images/2017/03/14/A1.jpg" alt="">
Tax was far from the only factor in play, of course. 
Experiences in the UK showed that when new lending rules are implemented, borrowers can take a little time to get to grips with the new criteria, before adjusting course accordingly. 
And then there was the interest rate cut on May 4, with borrowers - correctly as it turned out - anticipating that interest rate cuts are rarely delivered as a lone wolf. 
Another cut followed on August 3 and then investor loans were really off to the races. 
Further measures
It's tempting to argue that the market should just be left to sort itself out, and in some areas it already has.
When there are more rentals than willing tenants, then in time rents fall, vacancy rates rise, and owning an investment property naturally becomes are less than attractive proposition. 
But while it's common to see a high level of investor interest in the inner capital cities where rental demand is high, even far out into the suburbs and the traditional homebuyer heartlands there seems to be an unnaturally high number of investors perusing the market, which is both unhealthy and unsustainable. 
There is presently some talk of the incumbent Coalition making changes to the capital gains tax (CGT) legislation, but overall the government doesn't seem to be planning much in the way of cooling the housing market.
Meanwhile, the economy generally isn't in sound enough condition for markets to believe that the Reserve Bank will be hiking the cash rate any time soon.
It seems most likely that further measures will come via the regulator as 2017 rolls on, and will perhaps be manifested in higher mortgage rates for investors, or tougher qualifying criteria for investor loans, or both. 
 
PETE WARGENT is the co-founder of <a href="https://allenwargent.com/">AllenWargent</a> property buyers (London, Sydney) and a best-selling author and <a href="https://petewargent.blogspot.com/">blogger</a>.
His latest book is <a href="https://www.bigskypublishing.com.au/Books/General-Interest/Four-Green-Houses--and-a-Red-Hotel/1015/productview.aspx">Four Green Houses and a Red Hotel</a>.
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