The booming residential property market could force the banking regulators hand to cool down the market, but it will not be the RBA that slaps down prices. In this fortnights update we talk about potential restrictions on new home loans and why now is a good time for small business to be growing.
Rational ratios
The RBA will not raise rates to fight property price growth.
Why?
Because a crucial part of the RBA’s key objectives is price stability, economic stability and importantly ‘maintenance of full employment’.
If the RBA lifted rates to soon it would be counterproductive to all of those key goals so clearly outlined on their website.
The key objective they have been aiming for is full employment. Even before the virus crisis started this was their aim, and they were not achieving it.
When rates rise in the future it will be because the RBA is ‘achieving’ the target employment, which will result in their inflation target of between 2% and 3%. Only then after it is within that band in a sustainable fashion would the RBA lift the cash rate.
Just remember the cash rate is at emergency level lows for now but as the economy improves rates will rise, and we kind of want them to in some regard because it will show the economy is doing better.
But property prices are out of control right now and something needs to be done and affordability is an economic issue right?
Sort of.
There are other actors to combat rising property prices before prices actually because an economic issue and would force the RBAs hand, namely the banking regulator APRA.
Worth noting that property price growth right now is not a stability risk because the servicing of the debt is very manageable because rates are so low. That is to say because rates are so low people can repay debt. Another reason the RBA will not raise rates is that it would increase financial stress in the economy and increase the chance of people defaulting on debt.
APRA has a track record for slapping property booms down.
In March 2017 APRA cauterised an investor fuelled property price boom.
It did this by imposing limits on the percentage of banks mortgage lending books that could be to investors and have interest only repayments. They removed this temporary limit from the start of 2019.
Leading up to 2017 was a few years of extremely strong growth spurred on by local investors using the lower interest only repayments to buy up apartments and international (majority Chinese) investors putting money into new apartment buildings shooting up all over the country.
This limit was a targeted move to reduce the banks lending spree to investors and it worked.
By the end of 2017, the price growth had mellowed out and flatlined.
Another example of APRA’s tool kit is how they reduced the ‘serviceability rate’ from 7% to +2.5%. This meant banks would not be assessing your application as if rates were 7% but rather they would add 2.5% to the actual rate you were applying for. This was a very common-sense thing to do given rates are not going to be 7% anytime soon. The outcome of this was improved borrowing capacity for most people.
This time around it is not just investors fueling price growth it is first home buyers, mums and dads and everyone just looking to own their own dream.
So, this is not about limiting the type of repayment such as interest only it is about trying to ensure people borrow responsibly.
One clear way to direct this is to limit how much people can borrow.
But that would be counter productive to the reversal of the responsible lending laws and what the government is trying to achieve by loosening credit flowing into the system and to people to spend, so if they need to do that they need to find the ‘right’ way to do it.
The most likely way they will do it is to limit the amount of debt you can borrow for a property based on your income.
This is called the ‘debt to income ratio’ (“DTI”) and could become a big part of the conversation people have when they go to get a home loan.
Even now banks and lenders use the DTI ratio to make assessment on your maximum borrowing capacity, but APRA could force them to stick to it not just use it as a guide.
The DTI works by looking at the debt as a multiple of your household income. For example, if you borrow $1M but earn $200k a year then the DTI is x5 times. Current maximum DTI limits are around x7.
The impact of strict DTI ratios could see borrowing power restrained for many people but that would ultimately depend on what ratio APRA could impose, whether it be x5 or x7 is a big difference.
Consequently, the way a change in DTI imposed lending would seriously impact property prices is that it would reduce the amount people can borrow which means they can’t spend as much on a property which would deflate sale prices of properties.
We have talked before about how people generally spend as much as they can borrow and so the more people can borrow the more they spend, and with more spending and buying activity prices rise.
This is particularly true for property prices.
The leading data provider on property prices CoreLogic said median Sydney dwelling values reached a new high, which to avid readers won’t be surprised given we talked about this happening last year, to a record high of $895,933, which is slightly above the previous record median of $895,117 set in August 2017, which was shortly after the APRA controls came in. If APRA does come in with controls again this time it is likely the top might not be to far off.
The more people can borrow, the more they spend, the more buying activity there is the higher prices go.
Putting up the house
Should you put up your house to get a loan for your business?
This is a constant questions business owners must ask themselves and one they are often faced with when trying to get finance to grow.
They are often faced with it because when you go to a bank the first question they ask you is “how much is your house worth”? and that usually determines how much you can borrow.
Generally speaking, you can borrow up to eighty percent of the properties worth, or less.
This is an issue for a few reasons.
Frist because not every business owner has property and second even if they do they might not want to risk it by using it as security for a business.
The key advantage of using a property, commercial or residential, as security for a loan is that it lowers the risk for the lender and so lowers the interest rate paid.
Sometimes the best way to get the most money for the lowest amount is to put up property.
But it is not all about rate, often the repayment is more important because you want to make sure the repayment is suitable to the business cash flow.
This is where unsecured business loans come into the discussion.
These types of loans do not have property as security which technically makes them unsecured even though personal or directors guarantees are usually required.
This helps to separate the business finances from the family home.
There are more lenders and loan options for businesses now than ever before and the key with borrowing for a business, as most things in life, is balance.
Balancing cost, speed, complexity, limits, and outcomes.
This is a tough balancing act, and it is further complicated by the diverse mix of products and lenders in the market that all offer similar things which can get very confusing.
Fortunately, Skyward Financial partners with a spectrum of lenders to source loans for our business clients, so if you are planning to grow Let’s Talk.