WHAT IS THE HOME LOAN ASSESSMENT RATE AND WHY YOU SHOULD KNOW ABOUT IT?

When you apply for a home loan there is a high possibility that you will be under the impression that lenders will assess your ability to repay the said loan based on interest rates at the time of your loan application. However, that is far from the truth. Interest rates during a loan cycle are subject to shifts in the market and changes to cash rate. These changes can in turn affect your repayment ability. That is why when lenders assess a borrower’s loan application, they do so based on an inflated interest rate, as it gives both the lender and the borrower confidence that the loan repayments can be made without undue hardship. This higher rate is what the banks call assessment rate.

Each lender has a different mortgage assessment rate, which also means that each lender will offer you a different loan amount when you apply for a home loan. A further factor is the use of different mortgage assessment rates by lenders for different loans.

A bank’s Standard Variable Rates (SVR) are always driven by alterations in the cash rate of Reserve bank of Australia. So when a change happens a bank will then add an extra 2-3 percentage points to the official cash rate in order to arrive at their SVR. This is the moment when the banks will add the extra buffer known as the assessment rate which will typically be 2-3% above the bank s SVR.

WHY SHOULD YOU KNOW ABOUT IT?

The assessment rate has a direct impact on your borrowing capacity. If at any given point the assessment rate is high then it might just mean that you may not be able to borrow as much as you think you can. Furthermore, as we have seen in Australia over the past few years, RBA’s cash rate has actually fallen and they have now been stable for only over a year. On the other hand, assessment rates have either been stable or risen. Due to greater regulations, the gap between the actual (discounted) interest rate and the assessment rate is widening which makes it harder to borrow your desired amount as a first home buyer, refinancer or in this case property investor.

THE APRA CHANGES

In a letter to authorized deposit-taking institutions (ADIs) on 6th October 2021, APRA has told lenders it expects they will assess new borrowers’ ability to meet their loan repayments at an interest rate that is at least 3.0 percentage points above the loan product rate. Basically, APRA increased the minimum interest rate buffer it expects banks to use when assessing the serviceability of home loan applications. This decision of APRA was supported by the Council of Financial Regulators (CFR), comprising the Reserve Bank of Australia, the Treasury and the Australian Securities and Investments Commission.

WHY THE CHANGE?

The gist of all the reasons APRA had to make these changes can be summarized in two words, household indebtedness. The current environment of very low interest rates and rapidly rising house prices means that pressures on household indebtedness are likely to remain heightened. Household credit growth is expected to exceed household income growth in the period ahead, further adding to concerns around overall household indebtedness.  

A more highly indebted household sector presents risks to future financial stability. Highly indebted borrowers are likely to be less resilient to future shocks, such as from rising interest rates or a reduction in income. Macroeconomic impacts can be material if such risks materialize, with international studies suggesting highly indebted households are more likely to reduce their consumption in the event of a shock, amplifying the impacts of any economic downturn.

HOW DOES THIS AFFECT YOU?

The increase in the interest rate buffer applies to all new borrowers. However, across borrower cohorts, the impact of a higher serviceability buffer is likely to be larger for investors than owner-occupiers. This is because, on average, investors tend to borrow at higher levels of leverage and may have other existing debts (to which the buffer would also be applied). On the other hand, first home buyers tend to be under-represented as a share of borrowers borrowing a high multiple of their income as they tend to be more constrained by the size of their deposit.

This move is hugely significant for those who want to borrow the most money they can since now your capacity to borrow is being reduced. For example, if a lender had previously estimated your borrowing capacity at $500,000 as your maximum, these changes mean that it would be reduced to $475,000. These new rules will not affect your plans if you want to get a mortgage and not use your maximum borrowing power.

THE ROAD AHEAD

APRA’s potential interventions are a direct result of the booming property market. With prices increasing, there is no better time to buy an investment property. However, any changes to the financial lending market could have an impact on you and your property investment.

Nevertheless, any potential amendments should not deter you from seeking your financial freedom and growing your property portfolio. What you need is the right property finance solution and a trusted partner to walk the road with you. With imminent changes to the property investment lending market, finding a mortgage that meets your financial goals and repayment objectives is now more crucial than ever.

Property investors need to conduct the relevant research and factor in elements such as timing, their borrowing and repayment capacity, and ultimately their investment property strategy. However, the most crucial factor is identifying a financial institution that will support and underwrite your lending requirements. This lending support is vital, and investors must resist the temptation of going with the financial institution that offers the lowest interest rates. Instead, finding and applying to a lender that will allow you to build your portfolio is a far better option.