Borrowers face possible $227k hit as rates rise and lenders get tough

Two of Australia’s largest banks have tightened their home loan lending rules, as recent Canstar data suggests some Aussie home buyers could take a $227,000 hit to their borrowing capacity if interest rates continue to rise.

Two of Australia’s big four banks have announced this week that they are tightening the approval criteria for home loans, and will no longer accept applications from borrowers whose debt-to-income ratio (DTI) is too high.

The move comes against a backdrop of rising interest rates, with some analysts predicting further hikes in months to come, and concerns over what this could mean for Aussies hoping to get into the housing market, as well as those already paying off home loans.

ANZ and NAB are toughening their lending requirements

ANZ Bank announced this week that from 6 June 2022, it will no longer take applications from borrowers with a DTI of 7.5 or more. This is down from the bank’s earlier position, when it was prepared to consider applications from customers with a DTI of up to 9.

National Australia Bank (NAB) has also made moves to limit lending to heavily indebted borrowers, announcing earlier this week that it would reduce its debt-to-income ratio limit from 9 to 8. However, the bank has said it will still consider lending above that level in some circumstances, such as if an existing customer’s credit score is very high.

Commonwealth Bank and Westpac have yet to formally announce whether they will reduce their debt-to-income ratios for borrowers, although current policy for both lenders is to apply tougher scrutiny to borrowers with a DTI above a certain level.

Currently, CommBank has “tighter lending parameters” for borrowers with a DTI above 6, while Westpac likewise applies tighter scrutiny to borrowers with a DTI above 7.

Concerns for “vulnerable” home loan borrowers

The debt-to-income ratio is a measure of the debt a borrower has relative to their income, and banks and lenders use it as a key metric when assessing home loan applications, as part of their legal obligations to consider an applicant’s ability to repay the home loan they’re applying for.

The higher the ratio, the trickier it might potentially be for a borrower to repay a loan, and therefore the greater the risk that borrower might represent to a lender. As home loan interest rates begin to rise, Australia’s major banks are signalling that they are aware of concerns in this area.

When announcing the new tougher DTI requirements, ANZ told brokers that it was reviewing its lending policies against a backdrop of rising interest rates. The bank noted the fact that borrowers who take out loans at high multiples of their income are “more vulnerable to adverse changes in circumstances or loan conditions.”

ANZ said that its new limit is strict, and that there is “no appetite” to consider applications with a DTI of 7.5 or above.

The tightening of lending criteria comes within a month after the Reserve Bank of Australia (RBA) raised the official cash rate for the first time since November 2020. This move saw most major banks and lenders raise their home loan interest rates in response, and many analysts have predicted a further cash rate hike in June.

As interest rates rise, home loan repayments will get more expensive for Aussies with variable rate mortgages, and there have already been some concerns raised that further rises could see some borrowers end up in a position of mortgage stress, potentially unable to meet their repayments.

Cash rate hikes predicted to affect Aussies’ borrowing power

Your home loan borrowing power is the amount of money you might be able to borrow from a bank or lender, based on your financial situation and what you earn, as well as your expenses, debts and the size of home loan deposit you have saved.

If interest rates rise, then prospective home buyers may find that their borrowing power is reduced. Recent Canstar research found that the recent 0.25 percentage point increase in the official cash rate had this effect, lowing the potential borrowing power of a hypothetical Aussie couple on average dual incomes by 2.6%.

We considered scenarios in which the cash rate might rise further, finding that in an extreme case, if the cash rate were to rise to 2.00% from its April 2022 level of 0.10%, then the borrowing power of an average Aussie couple could be reduced by as much as 17.6%. These percentages are similar for a single-income household on the average Australian salary, with the caveat that such borrowers would often have a lower borrowing power to begin with.

You can see the possible impact that cash rate hikes could have on the borrowing power of single Aussies below:

Impact of Rate Hikes on Borrowing Power – Single Income

Source: www.canstar.com.au, 5 May 2022. Calculated using Canstar’s Home Loan Borrowing Power Calculator. The calculations assume a starting interest rate of 2.98% (the average owner-occupier, P&I variable rate on Canstar’s database) increasing in line with the cash rate. Other assumptions include a loan term of 30 years, gross annual income of $90,900 (Nov 2021; ABS Average Weekly Earnings, Full-time ordinary time), annual expenses of $16,500 for a single, 80% of income available to service a home loan, and a 3% interest rate buffer. All input and output figures of the calculator are rounded to the nearest $100.

The below table shows the possible impact that further cash rate hikes could have on the borrowing power of couples:

Impact of Rate Hikes on Borrowing Power – Dual Income

Source: www.canstar.com.au, 5 May 2022. Calculated using Canstar’s Home Loan Borrowing Power Calculator. The calculations assume a starting interest rate of 2.98% (the average owner-occupier, P&I variable rate on Canstar’s database) increasing in line with the cash rate. Other assumptions include a loan term of 30 years, two gross annual incomes of $90,900 (Nov 2021; ABS Average Weekly Earnings, Full-time ordinary time), annual expenses of $20,580 for a couple with no dependents, 80% of income available to service a home loan, and a 3% interest rate buffer. All input and output figures of the calculator are rounded to the nearest $100.

Cover image source: Adwo/Shutterstock.com.