- Tighter credit conditions are possible if the ratio between debt and income rises further
- In the past, APRA has implemented such changes
- These actions directly correlate in a decline in home values nationally
Interest rates are likely to remain at their current historically low levels for a few more years, so with a rampant housing market, what policies could be used to keep things under control? And what could their impact be?
Macroprudential
As their name suggests, macroprudential policies look to affect the total (macro) lending environment (prudential), ensuring borrowing standards are kept safe and secure, and do not get too risky or loose.
One macroprudential policy might be to tighten credit conditions (making it harder to obtain a loan), which could be triggered by higher household debt levels or a rise in a high-debt-to-income ratio, says CoreLogic.
As property values continue to rise and mortgage debt levels increase faster than long-term averages, the focus on housing credit policies is becoming more intense.
Recent Reserve Bank of Australia (RBA) post-meeting pronouncements feature the line that the bank is “monitoring trends in housing borrowing carefully and it is important that lending standards are maintained.”
The central bank says given that through previous rounds of macroprudential policies implemented by the Australian Prudential Regulation Authority (APRA) and the Banking Royal Commission, housing credit became much harder to come by, with a clear impact on housing activity and value growth.
“Any tightening of credit policies would likely have an immediate dampening effect on housing markets, the extent to which would depend on the scope and severity of the tighter credit conditions,” explained Tim Lawless of CoreLogic.
Impacts of previous action
As the chart (below) shows, the first round of macro-prudential action (2014) saw a 10% limit on investor credit growth, which made its impact felt in mid-2015.
The second round saw a 30% limit on interest on lending which was announced in March 2017. Home values subsequently declined across the country between late 2017 and early 2018.
Macroprudential Policy:
Monthly Change in National Dwelling Values
Values also declined as testimonies began for the Banking Royal Commission.
During each of these periods, the impact on housing trends was more prevalent in markets that had heightened exposure to the rules – especially in Sydney.
“Sydney was the epicentre of investment activity, with investors comprising almost 56% of mortgage demand in early 2015,” said Mr Lawless.
Mr Lawless noted that in the current environment the risk for credit tightening is focusing on overall debt accrual across the household sector as opposed to investment lending or interest-only lending.
Owner-occupier credit growth has been trending higher since June 2020 and has remained above the decade average since November last year. Record low interest rates are probably responsible.
“The proportion of loans being issued with high debt-to-income ratios is another warning sign,” said Mr Lawless.
“The latest data from APRA shows housing loans originated with a debt-to-income ratio greater than six times comprised almost 22% of lending through the June quarter; a substantial lift from a year ago when only 16.0% of new loans had a debt-to-income ratio this high.”
In response to these risks, higher serviceability assessments for borrowers may be introduced, which effectively raise the minimum interest rate used when assessing whether a borrower can service their loan.
“Ultimately, stricter credit conditions, should they be introduced, would flow through to less home purchasing activity and add to the headwinds of worsening housing affordability, higher levels of newly built supply and stalled overseas migration,” concluded Mr Lawless.
