Loan serviceability buffers questioned

Interest rate buffers are used to assess a borrower’s ability to meet mortgage repayments in the event of a rate rise.

The JP Morgan Australian Mortgage Industry report singled out Westpac as an example of a lender with a buffer rate of 6.8 per cent, just under two per cent above the current rate of repayment on a standard mortgage.

“That serviceability buffer is actually around the 10-year average mortgage rate,” JP Morgan banking analyst Scott Manning said.

“If you are assessing buffer ability on averages, rather than stressed scenarios, we question whether that is sufficient and we think maybe the three per cent buffer that the UK is proposing actually makes a bit of sense,” Mr Manning said.

The UK is currently running a proposal that would see rate buffers increase to three per cent.

While the RBA recently said that the use of such macroprudential tools is not favourable, it did suggest that increasing interest rate buffers would be its preferred option.

“The RBA has already run through its views on seven or eight different macroprudential policies,” Mr Manning said.

“They came up with the view that the best one with the least adverse outcomes is increasing interest rate buffers,” he said.

The report’s co-producer, Martin North of Digital Finance Analytics (DFA), said that while there is no publicly available loan-to-income ratio data in Australia, data from a DFA survey suggests raising the rate buffer by three per cent could hurt first home buyers.

A DFA survey of more than 26,000 consumers found a wide range of loan-to-income ratios among existing mortgage holders.

“A lot of the loan-to-income ratios that are at the higher end of the spectrum are directly associated with first home buyers,” Mr North said.

“People are stretching themselves significantly to get into the market,” he said, adding that even those who got into the market two or three years ago are still in some degree of difficulty because their income has only grown marginally.

“That tells us some things about how you might go about implementing loan-to-income ratio strategies,” Mr North said.

“You need to be quite careful because if you throttle back loan to income ratios you disproportionately impact first home buyers, which may not be what you want to achieve.”