APRA tightens up on interest-only lending

According to the regulator, this increased scrutiny has been in response to “an environment of heightened risks, reflected in an environment of high housing prices, high and rising household indebtedness, subdued household income growth, historically low interest rates, and strong competitive pressures”.

APRA has therefore written to ADIs advising that it expects the banks to:

• limit the flow of new interest-only lending to 30 per cent of total new residential mortgage lending, and within that:
• place strict internal limits on the volume of interest-only lending at loan-to-value ratios (LVRs) above 80 per cent; and
• ensure there is strong scrutiny and justification of any instances of interest-only lending at an LVR above 90 per cent;
• manage lending to investors in such a manner so as to comfortably remain below the previously advised benchmark of 10 per cent growth;
• review and ensure that serviceability metrics, including interest rate and net income buffers, are set at appropriate levels for current conditions; and
• continue to restrain lending growth in higher risk segments of the portfolio (e.g. high loan-to-income loans, high LVR loans, and loans for very long terms).

APRA chairman Wayne Byres said that APRA believes the current 10 per cent benchmark for growth in lending to investors continues to "provide an appropriate constraint in the current environment", balancing the need to continue to moderate new investor lending with the increasing supply of newly completed construction that "must be absorbed in the year ahead".

“APRA expects ADIs to target a level of investor lending growth that allows them to comfortably manage normal monthly volatility in lending flows without exceeding this benchmark level,” he said.

“Our objective with these new measures is to ensure lenders are recognising the heightened risk in the lending environment, and that their lending standards and practices appropriately respond to these conditions.”

Mr Byres added that lending on interest-only terms represents nearly 40 per cent of the stock of residential mortgage lending by ADIs — which is high by international and historical standards.

“APRA views a higher proportion of interest-only lending in the current environment to be indicative of a higher risk profile. We will therefore be monitoring the share of interest-only lending within total new mortgage lending for each ADI, and will consider the need to impose additional requirements on an ADI when the proportion of new lending on interest-only terms exceeds 30 per cent of total new mortgage lending.

“APRA has chosen not to set quantitative limits in relation to serviceability assessments at this point in time. However, APRA considers it important that borrowers retain some level of financial buffer to allow for unexpected events, especially for borrowers that have high levels of indebtedness.

“[We] will therefore continue to scrutinise serviceability assessments, and ADIs continue to need to advise APRA should they propose to change their existing methodologies or policies,” Mr Byres said.

The regulator has advised ADIs that it is also monitoring the growth in warehouse facilities provided by ADIs to other lenders. These facilities allow lenders to build a portfolio of loans that will eventually be securitised.

“APRA would be concerned if these warehouse facilities were growing at a materially faster rate than an ADI’s own housing loan portfolio, or if lending standards for loans held within warehouses are of a materially lower quality than would be consistent with industry-wide sound practices,” Mr Byres said.

He added that APRA continues to monitor the prevalence of higher risk mortgage lending more generally, including lending at high loan-to-income ratios, lending at a high loan-to-valuation ratios, and lending at very long terms or with long interest-only periods (e.g. beyond five years). 

The body said it will continue to observe conditions in the residential mortgage lending market, and may adjust the above measures, or implement additional ones, should circumstances warrant it.

HIA welcomes changes

The new changes have been welcomed by the Housing Industry Association (HIA), who said that the changes "provide a cautious and sensible approach to the home lending environment nationally".

“The measures focus on maintaining a steady growth in investor lending with a particular emphasis on managing interest-only loans,” said HIA’s chief economist, Dr Harley Dale.

“Importantly, the measures allow the ADI banks to assess loan applications across a broad and varied landscape. While house prices have been rising in Sydney and Melbourne, they have been trending downwards in Perth. Similarly, rental vacancy rates and rental prices have been moving in different directions and at varying pace across capital and regional centres.

“Australia’s housing market is not homogeneous. The banks are well positioned to apply these additional measures and do so with a considered and targeted approach so as not to adversely affect struggling housing markets,” concluded Dr Dale.

[Related: Banks move on interest rates out of cycle]