Finance Market Update - 8 October 21
Property prices will continue to rise, just at a slower pace. In this fortnights update we talk about potential restrictions being introduced for buying property and what that means for prices.
Six times more
How much money you make determines how much you can borrow to buy a property.
This has always been true, but new changes to regulations might make it a bit more true for many people as their borrowing power might decline.
It seems that with tear away property prices since the virus crisis started almost two years ago that the government is waking up and realising they need to do something about it.
We talked six months ago about what the government and APRA (the banking regulator) would change if they did step in to slow down the property market.
I specifically called out the Debt to Income (DTI) ratio as the lever APRA would pull to address price concerns. Avid readers would have seen this change coming six months ago.
Now, the treasurer has flagged this is exactly what is likely to happen. They could introduce a limit of about 6 times your household income to your mortgage.
This means banks are essentially obligated to ask how much you earn and only give you a loan based on your income and servicing, which is what they do not, just a bit stricter. For example, with the DTI changes if your household earns $200k a year you could at most borrow $1.2M
There are potentially very negative and adverse consequences for changing this is that it can lock people out of home ownership because they do not qualify for a loan or can’t afford it, and if people already have a loan but their circumstances change, and their income drops they could become mortgage prisoners and unable to move to a cheaper option.
In terms of borrower power based on DTI changes, as an example, if you can borrow $1.2M then at an 80% LVR the purchase price of the property you can buy is (only) $1.5M.
In Sydney there are not many houses for under $1.5M available.
This could push many buyers, especially first-time buyers, into apartments rather than houses. But it will also drastically reduce peoples general purchasing power.
On top of potential DTI changes, they are also raising the minimum serviceability rate by 0.5% to 3%. This means banks will add 3% on top of the actual rate they will give you to make sure you can afford it. This is a buffer and to stress test your servicing and ability to repay the loan as rates increase.
That 0.5% is estimated to reduce peoples borrowing power by about 5%.
DTI can be particularly stinging for many people as incomes in Australia have been largely flat for the better part of a decade which means with people’s ability to borrow to buy property directly linked to how much they earn will make people demand to be paid more.
Importantly, any DTI changes will likely impact investors more than people buying a property to live in. Why? Because investor rates are higher on average than owner occupied rates, which means the actual rate plus the three percent buffer is higher.
This makes me think the regulator is targeting investors more than owner occupiers, and I do not see DTI restrictions causing a property price recession.
But incomes will matter more.
The demand from workers for higher pay, plus the labour shortages from reduced immigration, will be upward forces on wages.
Increasing wages is also a sign of inflation, which we talked about in the last update as a force making people poorer even though they have more dollars.
As banks have to start telling people they can’t borrow how much they want people will look for alternatives.
In Australia the ‘shadow banking system’ of non-bank (and unregulated) lenders is still relatively small compared to other countries like UK or US, where non-bank lenders can make up 1 in 4 home loans. In Australia they are around 1 in 10 loans.
As people start to look to borrow more and banks say no they will ask to get loans from non-bank lenders. Non-bank lenders are not regulated by APRA and do not have to follow their 3% servicing or DTI metrics.
Banking from the shadows
A shadow banking system sounds more sinister than it is.
It simply refers to lenders outside of the scope of the banking regulator APRA, and many of these non-bank lenders are very good, but like any industry bad apples exist.
The non-bank lenders are generally reliable, faster to approve and settle loans than banks, and more generous with loan amounts and importantly will accept different forms of evidence to support your income.
For example, a bank will want 2 years full financials and tax returns and recent payslips to verify your income. This is commonly referred to as a ‘full doc’ application, where you give them the ‘full’ picture. The benefit of doing a full application means the bank sees more and can manage their risk better, which enables them to give the borrower a lower rate because of the perceived lower risk.
For non-banks, they will often accept the full application but importantly have an alternative option where you provide different forms or less evidence to show your income, this type of application is commonly referred to as ‘alt doc’ or ‘low doc’. An ‘alt’ application might accept a letter signed by the borrower and their accountant, or bank statements instead of two years financials.
This is very helpful for self employed people who do not have their paperwork up to date, but also very useful for people who might want to borrow more than the bank will give them.
However, with ‘alt’ doc applications and less information being given to the lender they are taking on more risk because they see less of the whole picture, so they charge a higher interest rate and fees.
For all of these reasons I still say that now might be a good time to buy property as prices will remain strong for the short to medium term, and with more expensive and highly geared loans from non-banks still enabling purchasing, prices will likely remain where they are now or move upward.
Rate increases by banks and lenders in addition to any new limits on DTI and borrowing power will take a lot of heat out of the property market, but prices will continue to rise, just more slowly.
We have seen breakneck price increases happening since the virus crisis started. Almost every week new suburb records are being broken and new highs reached.
The rate of increase is in some cases more than people would make during their job, being over $1,500 a week on average.
The previous height of property prices was in April 2020 and prices are up nearly 20% since then according to Core Logic and will continue to rise based on solid fundamentals and the five forces I bang on about quite often, namely high demand, low supply, low rates, FOMO, and government policy.
The changes to how banks can assess borrowing capacity might slow down price growth but prices will continue upward.