The Australian Prudential Regulation Authority has proposed letting lenders set their own minimum interest rate floor for use in serviceability assessments. 

In a letter sent out on Tuesday, APRA suggested deposit-taking institutions (ADIs) assess whether borrowers can afford their repayment obligations using a minimum interest rate of at least 7 per cent.

APRA has also proposed that banks' serviceability assessments incorporate an interest rate buffer of 2.5 per cent. 

At a glance:

• The Australian Prudential Regulation Authority has written to lenders, suggesting they remove 7 per cent serviceability buffer on home loans.
• APRA has also proposed that banks' serviceability assessments incorporate an interest rate buffer of 2.5 per cent.
• APRA Chair Wayne Byres said the operating environment for ADIs had evolved since 2014, prompting APRA to review the ongoing appropriateness of the current guidance.

APRA first introduced the serviceability guidance in December 2014 as part of its efforts to "reinforce sound residential lending standards".

They require the banks to assess all home loans against a floor of 7 per cent or 2 per cent above the rate paid by the borrower, whichever was higher.

The guidance was subsequently incorporated into Prudential Practice Guide APG 223 Residential Mortgage Lending, which APRA is now proposing to amend.

APRA Chair Wayne Byres said the operating environment for ADIs had evolved since 2014, prompting APRA to review the ongoing appropriateness of the current guidance.

“APRA introduced this guidance as part of a suite of measures designed to reinforce sound residential lending standards at a time of heightened risk. Although many of those risk factors remain – high house prices, low interest rates, high household debt, and subdued income growth – two more recent developments have led us to review the appropriateness of the interest rate floor,” he said.

“With interest rates at record lows, and likely to remain at historically low levels for some time, the gap between the 7 per cent floor and actual rates paid has become quite wide in some cases – possibly unnecessarily so.

“In addition, the introduction of differential pricing in recent years – with a substantial gap emerging between interest rates for owner-occupiers with principal-and-interest loans on the one hand, and investors with interest-only loans on the other – has meant that the merits of a single floor rate across all products have been substantially reduced."

The move has been welcomed by the Property Council of Australia, which described it as a "timely" move.

"It makes sense to revisit some of the measures originally put in place at the peak of the housing market. Different markets need different settings," PCA Chief Executive Ken Morrison said.

“A stable and well-regulated financial system is fundamental to our economic prosperity and it is appropriate that the guidelines for lending standards are regularly reviewed.

“As APRA notes, this is not about easing sound lending standards but recognition that the interest rate environment has changed with interest rates now at a record lows, and likely to remain so, the gap between the 7 per cent floor and actual rates has become quite wide.”

CoreLogic research analyst Cameron Kusher said while the changes would help some borrowers that can’t quite access a mortgage currently to get one, they are unlikely to result in a rebound of the housing market. 

"Should these changes be implemented it would potentially slow the declines further and may result in an earlier bottoming of the housing market (we currently expect the market to bottom in mid-2020)," he said.

"Despite that prospect, it will remain more difficult to obtain a mortgage than it has done in the past and we would expect that if/when the market bottoms a rapid re-inflation of dwelling values is unlikely."

A four-week consultation will close on 18 June, ahead of APRA releasing a final version of the updated APG 223 shortly afterwards.

Click here to read the full letter sent by APRA.

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