Important changes to your borrowing capacity

Borrowing capacity has probably never been tighter in the 20 years since I started ProSolution! This is delaying investment plans for some clients. However, my expectation is that this is temporary and an easing in borrowing capacity might not be too far away.  

How borrowing capacity rules have changed over recent years 

In 2019, the banking regulator, APRA told banks to include a ‘serviceability buffer’ of at least 2.5% above the actual interest rate to test borrowing capacity. In October 2021, it increased this to a minimum of 3%, when actual interest rates were circa 2% p.a. 

Therefore, if you are applying for a home loan today, your repayments will be tested at a rate of around 7.55% p.a. P&I over 30 years. Interest-only investment loan applications are tested at an interest rate of circa 8.35% p.a. on a P&I basis over 25 years. This means benchmark repayments for a $1 million home loan would be $84k p.a. (compared to $61k p.a. for actual repayments), and almost $95k p.a. for an interest-only investment loan (compared to $54k p.a. for actual repayments). Therefore, benchmark repayments are now over 80% higher than actual repayments for interest-only investment loans. 

To give you some context, benchmark interest rates over the past 20 years have typically ranged between 6% and 7% p.a. It is probably unnecessary for benchmark interest rates to exceed circa 7% p.a. on a permanent basis. 

Rising interest rates reduces your borrowing capacity 

The issue is that the RBA has hiked rates so quickly i.e., 2.50% over the past 6 months and the banking regulator hasn’t adjusted its benchmark interest rate guidance accordingly. The 3% p.a. buffer was prudent when the cash rate was only 0.10% p.a. but arguably excessive now. 

For example, a borrower needs to demonstrate they have over $62,000 of surplus income to qualify for a $1 million investment loan to buy an investment property: 

·      Rental income @ 3% of property’s value shaded by 70% to allow for expenses = $20,000

·      Less P&I repayments on $1m @ 8.35% over 25 years = $95,450

·      Add back negative gearing tax benefit = $13,000

·      Cash surplus required = $62,450 (which equates to an income surplus of $100k p.a. before tax)

The RBA would like to see lending volumes fall 

It is noteworthy that new home loan volumes have been unsustainably high over the past two years, as illustrated in the chart below. New investment home loan volumes have been above average too, but not to the sa

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