As more borrowers roll off their super-low fixed rates and try to refinance, many are finding themselves unable to pass serviceability tests. Annie Kane takes a look at why more loans are hitting the buffers, and what lenders are doing about it
The word ‘mortgage’ may literally mean ‘death contract’, but, for many borrowers, the term has more recently come to feel more like a prison sentence, than a death contract.
With rates rising and fixed-rate home loans expiring, nearly every broker has had at least one ‘mortgage prisoner’ client; a borrower who has not been able to refinance to another loan due to serviceability issues.
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According to the May 2023 Broker Pulse survey, conducted between 1 and 15 June 2023, 96 per cent of brokers said that up to 10 per cent of their clients had not been able to refinance or get a loan because they could not pass the 3.0 per cent serviceability buffer.
Moreover, more than half (57 per cent) of the 256 brokers surveyed estimated that up to 20 per cent of their clients were mortgage prisoners, while 43 per cent of brokers believed that at least a fifth of their clients were unable to pass APRA’s serviceability test.
Just 10 of the 256 brokers surveyed said that none of their clients were mortgage prisoners.
Why are more borrowers becoming mortgage prisoners?
The rapidly rising rate environment is largely to blame for sending more borrowers to mortgage prison. The Reserve Bank of Australia (RBA) has dramatically tightened its monetary policy in the past year, hiking the official cash rate 12 times since May 2022 to a decade high of 4.1 per cent (as at the time of writing, end of June 2023) as it fights to get inflation down to its target level of 2–3 per cent.
Many lenders have passed the majority of these rate rises to their home loan customers (though it’s estimated that there is a lag of around three months on borrower repayments). But, as most banks add on an additional 2 percentage points to the cash rate — even discounted variable rates are now hovering around 6 per cent and standard variable rates are up at over 8 per cent.
Given that the Australian Prudential Regulation Authority (APRA) expects banks to assess borrowers on their ability to repay a loan that is 3 percentage points above the loan rate, this means that even those accessing discounted rates are being assessed on their ability to repay a loan of 9 per cent. For the hundreds of thousands of borrowers rolling off super-low fixed rates onto standard variable rates, that buffer is up about 11 per cent. This is unachievable for most borrowers.
Those with high loan-to-value ratios (LVRs) are particularly vulnerable, with Lendi Group suggesting that more than 15 per cent of first home buyers (FHBs) rolling off their low fixed-rate periods could become ‘mortgage prisoners’ in the near future.
What is being done about it?
Given the record levels of borrowers refinancing at the moment, lenders are nervous about missing out on the new business. As such, several banks have been working on their exception policies to enable them to drop their serviceability buffers to help more ‘mortgage prisoners’ refinance.
For example, the Commonwealth Bank of Australia (CBA) and Westpac have both recently brought in a reduced serviceability buffer of 1 per cent for select customers refinancing their loan.
However, the alternative/modified serviceability interest rate buffer only applies to those with good credit scores and who have an LVR equal to, or less than, 80 per cent (and no LMI), among other requirements.
Speaking of the change last month, Michael Baumann, CBA’s executive general manager, home buying, said: “We know that due to the current interest rate environment, some home owners are facing challenges refinancing their home loans so we are introducing an alternate interest rate serviceability buffer of 1 per cent for select customers who meet strict eligibility criteria.
“The alternative interest rate buffer servicing assessment rate of 1 per cent will support customers refinancing existing home loan debts which do not pass the standard 3 per cent buffer over a 30-year period Principal and Interest loan but who would otherwise be eligible to refinance to a CommBank home loan.”
While the exceptions do not apply to those using guarantors or consolidating debt, for example, it’s expected that the changes will open up more options for prime borrowers who meet all requirements except for the buffer test.
Indeed, new data from mortgage brokerage group Lendi Group has found that three in 10 ‘mortgage prisoners’ (mortgagors who have been unable to refinance as they don’t pass serviceability tests) may now be able to do so.
Travis Tyler, chief product officer at Lendi Group, comments: “A 3 per cent serviceability buffer on a 5 per cent interest rate is impossible for many home owners to meet.
“Currently, a mortgage holder with the average Australian mortgage of $600,000 (based on national figures) at a 5 per cent interest rate would be assessed on whether they could afford repayments at 8 per cent or $4,630 per month.
“In contrast, a serviceability test at 6 per cent, which some lenders are offering, would bring that test down $3,685 a month, therefore being serviced at 20 per cent less, or a $765 difference per month, based on a 25-year loan term.”
APRA warns banks about lending exceptions usage
But as a growing number of lenders have begun offering lending exceptions for those looking to refinance, the prudential regulator has sat up and taken notice.
It’s main concern? That serviceability policy exceptions, which have historically accounted for between 2 and 3 per cent of the banks’ total housing lending, may ramp up and upset the strength of the financial system.
In June, APRA therefore wrote to the regulated banks to remind them of their obligations and warned them that those with higher volumes of lending exceptions will be faced with “heightened supervisory attention”.
APRA chair John Lonsdale warned: “APRA requires banks to have prudent policies and processes for dealing with exceptions to policy. Large volumes of exceptions can create risks by weakening banks’ risk profiles and increasing the vulnerability of their loan books to future shocks…
“It is important that exceptions are used in a prudent and limited manner, so as not to undermine the intent of the core policy. In using exceptions, APRA expects banks to make a prudent assessment of repayment capacity so that there is a good outcome for borrowers and the financial system.
“Prudent banks would have acceptable reasons and clear justifications for loans written outside policy,” flagging that banks should also consider their responsible lending obligations.
While CBA has confirmed that the decision to introduce its alternate serviceability buffer was made in consultation with APRA and followed further clarification and guidance from the regulator, APRA has emphasised that the regulator would be “monitoring exceptions trends closely and may request additional information to assess how banks are managing risks”.
