Investment lending rules to be tightened this year

lending rules

Almost everyone is predicting that property prices will surge higher this year. In fact, the newspapers are already full of stories about properties selling well above reserves.

Low stock levels are partly responsible for the currently exuberant property market. That exuberance might cool as more stock becomes available. But the RBA and the government do not want prices to rise too quick as it might create a bubble, and all bubbles pop eventually.  

Predictions of rising property prices

Westpac’s chief economist, Bill Evans predicts that Australian property prices will rise by 20% over the next two years. Most other economists agree with him.

Mr Evans cited Australia’s better-than-expected economic recovery, the vaccine rollout and historically low interest rates as the reasons for his optimistic property price prediction.

According to ABS lending indicators, the property market is still dominated by owner-occupiers. However, as overall sentiment improves, it is likely that investors will return to the market and that could further fuel price rises. The government could become concerned if it believed growth rates were unsustainable.

Imminent loosening of lending rules

Last year the government announced that it would scrap the ‘responsible lending’ rules in order to speed up loan approval times and eliminate the ‘one-size-fits-all’ approach (i.e. give banks more discretion). The practical consequence of this proposal change is that lenders may no longer have to ascertain what you currently spend each month (including discretionary expenses). Instead, they could use a benchmarks. In effect, for many borrowers, it would increase their borrowing capacity.

The Senate Committee recently recommended to the government that these proposed changes become law. The Bill will now need to be debated and passed in the Senate and the House of Representatives before it becomes law. If the Bill is ultimately successful, this could further fuel property prices.

Why the RBA cannot increase interest rates

There are two main reasons why the RBA probably will not increase the Cash Rate.  

Firstly, as highlighted by Governor Lowe in a speech in October 2020, the lowest 40% of income earners have been impacted by Covid the most. Whereas higher income earns have been largely unaffected. In fact, most recent data indicates the top 40% of income earners are earning more than pre-Covid. Therefore, an increase in interest rates will adversely impact lower income earners who can least afford it.

Secondly, an increase in interest rates would be very bad news for the federal (and state) budget deficit. The Australian federal government total borrowings are tipped to reach $1 trillion. A 1% p.a. increase in interest rates would cost the government an additional $10 billion. Politically, this is not an attractive prospect. As such, the government has an incentive to maintain low interest rates.

How to cool an overheated property market

If the RBA doesn’t feel it’s appropriate to cool the property market by increasing the Cash Rate, then the next best method is to change prudential lending standards. They could achieve this in one or a combination of ways:

  1. Increase interest rates for investor mortgages and leave owner-occupier rates unchanged (investor mortgage rates are already between 0.40% and 0.80% higher than owner-occupier rates). The government (APRA) could do this by requiring the banks to hold more capital for non-owner-occupier loans. That would increase the banks’ cost to hold investment loans and no doubt, they would pass that higher cost onto borrowers.  
  2. Limit the maximum loan to value ratio (LVR) for investment loans. At the moment, investors can borrow up to 90% of a property’s value – meaning they only need a 10% deposit plus costs. The government could reduce these LVR limits, like the Reserve Bank of NZ did last month. Most banks in NZ will now only lend up to 60% of a property’s value to investors. It will be interesting to see whether this is enough to cool the heated NZ property market.
  3. Increase the benchmark interest rates for investors. A benchmark interest rate is used when a lender calculates your borrowing capacity. It provides a buffer, to provide for future interest rate increases. The higher the benchmark interest rate, the lower your borrowing capacity.

When will this happen?

I think it’s very likely that the government (APRA) will tighten lending rules for investors sometime over the next 6 to 18 months. Of course, this is dependent on property prices. If price rises are considered sustainable, borrowing rules do not need to change. 

What should you do now to prepare for tighter lending rules?

Lock in access to as much equity as possible over the next 6 months. Depending on the type and location of your property/s, I would probably be inclined to wait one to two months before getting your properties revalued. This will allow for some more comparable sales to occur. Then, around April or May, I would ask your mortgage broker to revalue your properties and lock in my borrowing capacity to 80% of those new valuations. The exact timing of this does depend on your circumstances.

Notwithstanding the prospect of future lending rule changes (as discussed above), it is always a good idea to maximise your access to borrowings, even if you have no immediate plans.

Don’t get sucked in by FOMO. Run your own race

Some people worry about the prospect of future property price rises and feel a sense of urgency to buy property now, before they rise further. Don’t!

Of course, you shouldn’t procrastinate. If you are ready to invest, you should certainly do so. But by the same token, if now is not the right time, do not despair for three reasons:

  1. My analysis proves that the price you pay for a property is largely irrelevant. What is far more important (by a factor of 10) is the quality of the asset you buy;
  2. Property is a long term investment. You should plan to hold it for many decades. So there’s no point getting anxious over a few months. Its immaterial; and
  3. Discretionary vendors will be encouraged by recent results. As such, we should expect the supply of properties ‘on the market’ to increase. This may have a cooling effect on prices – or at least temper price rises. We must remind ourselves that prices are able to move in both directions.  

One thing is almost for sure. Interest rates are likely to remain low for an extended period of time. That creates financial opportunities in itself.