Having an all-time low RBA cash rate of 0.75% is presenting some challenges for banks and the RBA alike.
For many people, the lower interest rate environment has not provided lower interest rates or lower repayments on loans as intended. In fact, the macro-prudential regulations imposed on banks by the Australian Prudential Regulation Authority (APRA) have increased investment home loan rates by over 0.50%. In addition, the new restrictions on paying interest-only have resulted in a larger pool of maturing loans moving across to Principle and Interest repayments.
For example, on a $500,000 loan the difference between interest-only, and principle and interest repayments is $1,000/month or $12,000/year. This can create a large cash burden on many families and/or property investors, particularly when wages are not rising and bonuses and commissions are in decline.
There are however some green shoots for borrowers with an easing of the affordability criteria banks use when assessing a loan. There is a realisation by the RBA and the regulators that we are in a prolonged cycle of low interest rates, and that the old assessment rates for home loans at 7-8% is not reflective of this current cycle.
Although we may assume that a lender applies its standard variable rate when calculating how much you can borrow, this is not the case. Instead, lenders use an altered rate – or assessment rate – which is typically higher than the standard variable rate. The primary reason for this is to account for the possibility of future rate increases. High assessment rates ultimately impact affordability and ability to service a loan, and in the current environment this results in lower loan approval rates, despite the record low interest rates.
The banks have recently been given flexibility by the Australian Securities & Investments Commission (ASIC) to reduce the assessment rate to as low as 5.25%. This lower assessment rate and more consistency from the banks on assessing living expenses will hopefully generate the return of confidence for home buyers to borrow. If you are considering purchasing a property or making changes to your current loan structure, a professional mortgage adviser can help you understand the options available.