What do new bank regulations mean for investors?

Residential Mortgages will be more challenging to get.

On 31 March 2017, the Australian Prudential Regulation Authority (APRA), the body that regulates how banks operate, further clamped down on Australian banks and their ability to lend, by implementing new rules to curb the pace of activity in the Australian housing market. The measures are particularly designed to manage the heat being experienced in Australia’s two biggest housing markets, Sydney and Melbourne.

These rules will limit the number of new interest-only loans to 30% of total new residential mortgage lending and within that, place strict internal limits on the volume of interest-only lending at Loan-to-Value ratios (LVRs) above 80%.

There will also be much stronger scrutiny and justification for loans at LVRs greater than 90%.

Right now, interest only loans represent about 40% of the residential mortgage market. This concerns APRA as this type of loan is appealing for investors, which, are more prone to creating speculative bubbles. At 40%, Australia sits at a relatively high level compared to foreign peers.

In a letter to the banks APRA noted…

“The environment of heightened risk that has prevailed for the past few years has not lessened: the environment remains one of high housing prices, high and rising household indebtedness, subdued household income growth, historically low interest rates and strong competitive pressures.”

As the chart below shows, after successfully reducing the percentage of new interest only loan approvals during 2015, after first implementing new regulations in December 2014, 2016 saw the number of interest only loans start to creep back up again.

(Source: APRA, AMP)

This rise also coincided with a 10.9% increase in national house prices, which was the fastest pace of national house price appreciation since 2009. This was led predominately by Sydney and Melbourne which recorded 15.5% and 13.7% growth respectively.

So, what does all this mean for investors?

• Well to start with, it’s not panic stations. Banks will still lend because they need to in order to stay in business. What’s more, APRA certainly doesn’t want to slam on the breaks either as that would have much broader ramifications for the overall Australia economy and that’s not good for banks as well. APRA is simply trying to manufacture a cooling in the lending market and de-risk the banking system. I suspect that most policymakers would be happy if Melbourne and Sydney house prices went sideways for the next 5 to 7 years.
• The measures will, however, have an impact on investors. For starters, one should not assume that you will be able to automatically rollover your interest only loan on maturity at will with the same bank anymore. Some banks just won’t be able to give you the simple rubber stamp like they did before.
• If that’s the case, borrowers should be getting more active with who they are borrowing money from. Just because you have had a great relationship with a bank in the past, this doesn’t necessarily mean they will be able to service all your needs into the future.
• Some existing investors with multi-property portfolios who plan to release equity at high LVRs to buy additional property will find it much harder to do so.
• When considering your cash flows, you may need to increase your provisions for unexpected cash outflow increases, if you are getting close to your interest only term expiring. You may find it a little slower extending your term moving forward. And if you are approaching the end of your interest only period, you should prepare early and speak with your financial adviser or finance professional well before your interest only term expires.

Being a successful investor is all about being prepared.