How the APRA’s Guideline Tightening Affects Residential Home Buyers
In March 2017, the APRA placed restrictions on interest-only loans. These restrictions will primarily affect investors. But they have some knock-on effects for residential home buyers.
Some argue that there’s a housing issue in Australia. The rate of property price increases, particularly in the major cities, has led to many people struggling. Residential home buyers must raise even bigger deposits and secure more financing.
There are several issues that play a role in this increasing house prices. But some of the blame lies at the feet of Australia’s favourable investment climate. Investors have had access to loan products that residential home buyers often can’t secure. This includes interest-only loans, which lower investors’ monthly repayments.
The Australian Prudential Regulation Authority (APRA) has taken notice of this issue. In March 2017, it decided to impose more restrictions on lenders when it comes to investment loans.
But it’s not just investors that these restrictions will affect. Residential home buyers may also have to deal with some issues related to this guideline tightening.
What Does the APRA Do?
The APRA has acted as Australia’s chief financial regulator since its formation in 1998. Funded mostly by the institutions that it oversees, it imposes regulations based on various markets.
In the case of the property market, the APRA oversees the work of lenders. This includes banks and smaller lenders. Their aim is to ensure lenders don’t overstep their bounds when it comes to their dealings with borrowers. It oversees the mortgage market and makes changes based on its direction. This offers protection to both lenders and borrowers.
To achieve this, it operates to five key standards:
- Integrity. A commitment to acting without bias to ensure what it benefits the larger Australian community.
- Collaboration. Seeking out opinions from an array of sources to make more informed decisions.
- Respect. Do not discount the opinions and ideas that others share. The APRA aims to show respect in all that it does.
- Accountability. The organisation accepts full responsibility for its mandates. It also encourages scrutiny from others.
- Excellence. The maintenance of high standards in everything that it does.
The organisation creates guidelines in accordance with these standards. The overall aim is to provide a healthier financial outlook for Australia.
The New Regulations
In accordance with its mission, the new regulations aim to create a better buying climate for residential home buyers. The APRA has recognised some of the issues that increased investor lending has caused. These include:
- Creating more demand for residential property.
- Increasing the prices of residential property.
- Making it more difficult for residential home buyers to secure funding.
In fact, some statistics from the beginning of 2017 shed some more light on the issues. The Australian Bureau of Statistics noted a marked increase in investor lending during 2016/17. It recorded a 27.5% total increase. January 2017 alone saw a 4.2% increase.
The disparity shows when you see the statistics for residential home buyer loans. These fell by 0.2% in January 2017. This is just a small sampling of the stats that may have influenced the APRA’s decision.
So, what do the regulations say?
The most important of them is a restriction on interest-only loans. From March 2017, these loan types can only make up 30% or less of a lender’s offering. This is important because investors often use interest-only loans to boost their portfolios.
Other restrictions include asking lenders to take more care with high-risk loans. But it’s the changes to interest-only loan frequency that have the biggest effect.
What is an Interest-Only Loan?
As the name implies, interest-only loans require you to pay only interest on your home loan.
Here’s how it works. Your home loan has a principal. This is the amount of money that the lender has allowed you to borrow.
With a typical loan, you repay a portion of this principal each month, alongside interest. The exact amount depends on the size of the loan.
Things work differently with an interest-only loan. For a fixed term, you only repay interest each month. This means that the loan’s principal doesn’t decrease at all during the interest-only period.
How much interest you pay depends on the loan type. A fixed-rate loan means you pay the same amount of interest each month. For example, you may pay $2000 per month until the end of the fixed-rate term. This is because the principal remains the same and you have a fixed interest rate. But this will rise to over $3500 later on.
However, you can also take out a variable rate loan. This rate changes depending on the state of the market. As a result, you may find yourself repaying different amounts depending on the rate. Despite this, your principal doesn’t reduce. The interest you repay is still based on the full loan amount.
Investors often use these loans to improve cash flow and expand their portfolios. The lower monthly repayments allow them to save money. They can then use this saved money as a deposit on another property.
The problem with this strategy is that it makes it harder for residential buyers. Investors have an advantage because of the lower monthly repayments. This means they can often offer more for a property than a residential buyer.
Interest-only loans aren’t solely the domain of investors. Some residential buyers can access them too. However, they typically come with tight restrictions. Plus, lenders will want to see that you can handle the burden when the interest-only period ends.
Here are the pros of these types of loans:
- They allow for lower monthly repayments near the beginning of the loan period.
- Investors can use them to make large tax deductions.
- They’re useful for borrowers looking to secure construction loans.
However, the loans do come with some cons:
- The borrower faces higher monthly repayments when the interest-only term ends.
- Your loan’s principal does not fall.
- Lenders may impose a higher interest rate than they do for other loan packages.
- You’ll spend more over the lifetime of the loan.
The Effects on Residential Buyers
As mentioned, these new restrictions primarily affect investors. But residential buyers may also run into some issues. Moreover, they may benefit from the new guidelines. Here’s a rundown of the effects as they pertain to residential buyers.
Effect #1 – Possible Tighter Lending Restrictions
Lenders must impose tighter lending restrictions as part of the regulations. It’s possible that these tighter restrictions will carry over to residential buyers. The changing climate may make some lenders wary of high-risk borrowers. If you’re not able to offer a high deposit, you may have to jump through more hoops to secure a loan. The same goes for those on lower incomes.
Effect #2 – A Cooling Property Market
The rise in Australian house prices is one of the main reasons given for the new guidelines. Investor spending has created more demand, which increases property prices.
Restricting investor lending like this reduces the demand for residential properties. Generally speaking, less demand means lower prices. We may see the market shift in favour of buyers in the coming years.
What does this mean for residential buyers? Hopefully, the restrictions will lead to property prices falling. This means that you don’t have to secure as much funding to buy a property. You may also get away with using a lower deposit.
The house price figures from 2017 suggest that this cooling is already in effect. While property prices still grew during the year, the rate of growth halved during the last six months. In fact, there was only a combined growth of 1% across all of Australia’s capital cities. Sydney even experienced a 0.1% drop.
If such growth slowdown continues, residential buyers will find it easier to buy new homes.
Effect #3 – Lower Interest Rates
A slowdown in property price growth may also have an impact on interest rates.
It all depends on the actions that the Reserve Bank of Australia (RBA) takes. Restrictions on interest-only loans give the RB some space for manoeuvre. Ideally, it will use this space to keep the interest rates fairly low. Larger increases in house prices may force an interest hike, which affects all borrowers.
This is because lenders base their interest rate offerings on what the RBA says. Residential buyers may be able to take advantage of cooling house prices because of this. You could secure a lower interest rate on your loan. As a result, you pay less over the course of the loan.
The RBA has an added incentive to keep interest rates down. It wants to spur on the non-mining recovery in Australia. Lower interest rates help it to do that as they mean people have more money in their pockets.
Effect #4 – Investors May Take Out Owner-Occupier Loans
The chief benefit of investor loans is that they allow investors to repay less money per month. The APRA’s restrictions make this more difficult. As a result, we may see what some refer to as a “big switch”.
This is when investors realise that regular home loans offer more benefits than investment loans.
This is already happening in some areas. Investors have switched over $55 billion of loans from investment to owner-occupier loans in the two years up to June 2017. In fact, June 2017 alone saw $1.3 billion worth of switching.
The problem with this is that it eats into loan availability for genuine owner-occupiers. You may find it more difficult to get a loan because investors have made such a switch.
The Final Word
The APRA’s regulation changes have wider ramifications than you may expect. They don’t just cause issues for property investors. Residential buyers also have some issues to deal with. While the regulations benefit them in some areas, they may cause issues in others. Banks may tighten their lending criteria. Plus, there’s the issue of investors switching over to owner-occupier loans.