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Mortgage crackdown to crimp borrowing capacity
Australian Financial Review Apr 4 2017 11:00 PM
Jonathan Shapiro, James Frost
A mortgage lending crackdown could cut in half the amount a typical household can borrow once higher living expenses and greater interest rate buffers are applied.
A typical couple with an existing mortgage would see borrowing capacity reduced from $450,000 to about $235,000, according to Fitch Ratings, which presented a worked example to clients in 2016.
The analysis was in anticipation of tougher lending standards that would require lenders to assume higher interest rates and living expenses when writing mortgages.
It shows that tougher enforcement of responsible lending has the potential to pull credit out of the system by dampening the borrowing capacity of households keen to get a foothold into a rising market.
It follows steps announced by the Australian Securities and Investments Commission to up its surveillance of lenders and brokers that encouraged borrowers to take out interest only loans, and those that understated living expenses to help customers borrow more.
Fitch Ratings' David Carroll said regulators had already pushed lenders to increase the assumptions they use to calculate living expenses, telling them to use the higher of the Household Expenditure Measure or the expenses stated by the borrower in their applications.
"Lenders are underwriting loans based on principal and interest repayments with interest rate buffers in place," he said.
"Borrowers are however making repayments based on the lower actual rates and as rates move higher this will impact overall household expenditure which may result in increased arrears."
But Mr Carroll said at present there was no evidence of stress in the system.
"The reality is that arrears are low, mortgages in possession are low and losses are low. We don't know if this can get any better."
Some analysts believe that an overstatement of incomes and understatement of expenses has become widespread in the mortgage market and brokers and banks help borrowers get the loans they need to afford a property.
A research report published by UBS in October found that 28 per cent of mortgage applications – or 344 out of a sample of 1,228 Australian borrowers – contained "factually inaccurate" information.
Of those that provided false information, 14 per cent overstated their income while 26 per cent understated living expenses.
ASIC officials discouraged lenders from using simple indices of living expenses when there was more accurate data. Some have suggested lenders should extend credit based on tax returns rather than recent pay-slips to make more accurate income assessments.
On Friday, the Australian Prudential Regulation Authority told banks they would need to limit interest only loans to 30 per cent of all new loans, from their current 40 per cent level. It said it was "closely monitoring the trend" of lending to borrowers that had less than $200 left over after expenses and loan servicing.
Mr Carroll welcomed the increased focus on interest only loans and said Fitch has been concerned about interest only loans to owner occupied borrowers for some time because it was related to "borrower serviceability".
Fitch, like other credit rating agencies, has become concerned about rising household debt, which at 123 per cent of GDP is only slightly below Denmark, the most indebted nation of households.
"It's fair to suggest that the expenditure numbers are generally understated and that 40 per cent of borrowers are opting for interest only loans is a case in point," said Ream Investment House's Andrew Papageorgiou.
The Household Expenditure Measure is calculated using a median spend on basic items but also takes into account spending on alcohol, eating out and daycare. While the measure is more prudent than the Henderson Poverty Index, regulators have said it is too simplistic in estimating true expenses.
Bank of Queensland chief executive Jon Sutton said there had been "pages and pages" written about the HEM benchmark, which had been employed by the banks instead of actual expenses at the bank's interim results last week.
"The regulator has been very prescriptive about responsible lending. We have always validated 100 per cent of our loans."