The APRA’s New Guidelines – What’s Changed and What Hasn’t

In March 2017, the APRA introduced new guidelines that affected homebuyers. Both investors and owner-occupiers may have to deal with changes. This article looks at what the APRA did and how it may affect you.

The Australian Prudential Regulation Authority (APRA) has recently made changes. Established in 1998, the APRA oversees many of Australia’s biggest financial institutions. This includes most of the banks and lenders that you get home loans from.

The latest changes, introduced in March 2017, have had a major effect on homebuyers. Targeted primarily at property investors, the changes affect owner-occupiers too.

This article breaks those changes down and looks at the effects they’ve had.

What Were the Changes

The changes aimed to reduce the number of interest-only loans that lenders give out. The biggest change was the introduction of a new limit. Today, only 30% of a lender’s home loan output can consist of interest-only loans. The rest must primarily be traditional home loan products. The overall aim is to ensure owner-occupiers gain access to loan products.

However, several other changes fall within this restriction. Within the blanket limit, the APRA has introduced several other guidelines. These include the following:

  • A major reduction in interest-only loans offered to people borrowing for over 80% of a property’s value. This is likely the area that will see the most cuts to meet the 30% limit. Most investors will now need to raise a minimum of 20% for a deposit on a property purchase.
  • Following on from that, the APRA has asked for further restrictions. It wants lenders to limit the amount of interest-only loans it offers for those who want to borrow 90% of a property’s value.
  • The APRA has called for lenders to re-examine their serviceability metrics. Serviceability is the term lenders use to define your ability to repay your loan. It includes several factors, including your income and expenses. The current interest rate also affects potential serviceability. The APRA wants lenders to ensure their metrics meet current property market conditions.
  • Further restrictions when it comes to high-risk loans. Such loans place both the lender and borrower at risk. A high-risk borrower is more likely to default on their loan. Examples of such borrowers include those who borrow large amounts of money with barely enough income to cover it. Those who borrow 90% or more of a property’s value also fall into this category. So too do borrowers who ask for extra-long loan periods.

Beyond all this, the APRA has asked lenders to ensure they don’t surpass 10% growth in investor loan output.

To put it simply, the APRA wants to make it harder for investors to access home loan products. In particular, it wants to make it harder for them to access interest-only loans.

Why Would the APRA Do This?

To understand the reasoning, you must understand interest-only home loans.

Every home loan has a principal. This is the total value of the loan. For example, a $500,000 home loan has a principal of $500,000.

With a traditional mortgage, you make repayments that lower this principal each month. Moreover, you pay interest on the remaining principal each month. These are principal and interest (P&I) home loans. They’re what’s predominantly available to owner-occupier homebuyers.

Interest-only loans change that structure. Instead of repaying the principal, you only pay the interest on the principal. This means the principal sum doesn’t decrease for the duration of the interest-only period.

There are several reasons why investors do this. Primarily, property investors use these loans to lower their monthly outgoings. This can help with cash flow, especially when managing a large portfolio.

It also frees up money for use elsewhere. An investor might use this type of loan to save a few thousand dollars per month. This money then gets put towards the deposit on another property. They can also claim tax incentives when using this type of loan.

The downside is that the principal is still there. Once the interest-only period ends, the borrower faces larger repayments for the remaining life of the loan. Unwary investors could also end up spending more than they should due to poor preparation.

Simply put, they’re risky loans. Yet about 60% of investors have them instead of traditional loans. Moreover, 25% of owner-occupiers use interest-only loans. That’s a lot of people who may default when they have to start repaying the principal.

But that 60% figure also highlights another larger issue. The accessibility of interest-only loans made it easier for investors to buy property. This works out well for property investors. But it causes issues for owner-occupiers. Those looking to buy homes for residential purposes often find themselves priced out of the market.

That’s because more investors means more demand for properties. Sellers can ask for more money. Investors have access to this funding because of the nature of their loans.

So, the overall aim of the APRA’s guidelines is fairly simple. It wants to redress the balance when it comes to lending. Firstly, it aims to reduce the risk that lenders take on. But it also wants to prompt changes in property prices. Ideally, the measures will lead to cooling growth in the property market. This should make it easier for owner-occupiers to purchase property.

What Hasn’t Changed?

The first thing to note is that these regulations don’t make it impossible to get an interest-only loan. You can still get one from most major lenders. However, you’ll likely have to jump through more hoops to manage it.

Moreover, the general process for applying for any home loan remains the same. These guidelines haven’t changed how you get a loan of any kind. Instead, they’ve placed restrictions on a certain type of loan. These restrictions may have a knock-on effect in terms of what the lender asks for before approval. But the actual process remains the same.

Furthermore, the new guidelines haven’t caused the Reserve Bank of Australia’s (RBA’s) cash rate to change. As of April 2018, it still stands at 1.5%. This marks about a year and a half of no changes. Theoretically, this should mean that interest rates for P&I home loans don’t increase. However, that’s dependent on lenders as much as it the RBA.

What Are The Effects?

This article has mentioned some of the basic effects that these new guidelines may have. But here’s a more detailed rundown of the changes they’ve prompted.

Effect #1 – Fewer Investor Loans

The most obvious effect is that investors find it harder to get interest-only loans. As a result, the number of investor loans taken out has fallen. Investors have to wait longer to ensure they meet the lenders’ new criteria for the loans. The June 2017 investor loan growth figures highlight this. The sector achieved a 0.4% growth for the month. At the time, it was the lowest monthly growth figure for more than one year.

But this reduction in investor loans has an interesting side effect. Investors are not only not taking out investment loans. It also seems like they’re taking out more owner-occupier loans.

Here’s why they’re doing this. Every loan that a property investor takes out is essentially a calculation. They’ve realised the increased restrictions on interest-only loans now cost them more money. In fact, they cost them so much more that owner-occupier loans offer a better alternative.

The investor can benefit from this if they choose to occupy the investment property. Many may take this route and wait it out. When the climate becomes more favourable to investment loans, they’ll switch back.

The RBA released figures to show the scale of this switch. In June 2017, investors switched $1.3 billion of investment loans to owner-occupier loans.

The bad news is that this tactic makes owner-occupier loans less available to residential buyers. Investors with bigger pockets make it more difficult for legitimate owner-occupiers to borrow.

Effect #2 – Property Prices Should Fall

Fewer investment loans should mean fewer investors trying to buy property. This lowers demand to the point where sellers have to drop their prices. Owner-occupiers can then take advantage of this to buy property.

That’s the theory, at least. But has it actually happened?

While there hasn’t been a huge fall, cooling has certainly occurred. The December 2017 average house price figures shed more light on this. They revealed that property prices fell by 0.3% across the nation. Property price drops in Sydney and Darwin were the major catalysts for this fall.

But prices cooled throughout the year too. Over the course of 2017, property prices increased by 4.2%. This may seem like a lot until you compare it to previous years. In 2016, prices went up by 5.8%. There was an enormous 9.2% increase during the course of 2015.

So, it looks like the new guidelines have had the desired effects. At least, to an extent. Many analysts predict further cooling of the market throughout 2018. Ideally, this will mean that more owner-occupiers can purchase property.

Effect #3 – Higher Investor Loan Interest Rates

Lenders aren’t just restricting the number of investor loans that they accept. They’re also raising the interest rates on them. In fact, many have raised rates so that they’re higher than owner-occupier loan rates.

This is the catalyst for the switching mentioned above. But it also affects those who have kept their current investor loans. Those on fixed rates may not have to worry until the end of their fixed terms. But those on variable rate loans may have already felt the sting of these rate hikes.

Some lenders have raised their rates by up to 40 basis points. Moreover, the majority have done this. As a result, investors can’t switch to another provider in the hope of getting a better rate.

The Final Word

We’re still seeing the fallout of the APRA’s most recent guideline changes. But they do seem to have had an effect. The number of investor and interest-only loans granted has fallen. Plus, property prices seem to be in the process of cooling. But we may still have to wait a while before we can predict the long-term effects.

But where does this leave you if you want to buy a property? Both investors and owner-occupiers can still access home loans. The former may just have to meet tighter criteria. Investors may also see their borrowing power reduced due to tighter restrictions.

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