Rising rates could cut the amount you can borrow for a home loan by 20%
While the impact of rising interest rates on existing borrowers is well known, those buying a home will also be forced to make adjustments, namely to settle for a smaller loan.
In a recent speech, the Reserve Bank’s head of domestic markets, Jonathan Kearns, said this year’s rate hikes have already reduced the amount of debt potential borrowers can take on by a fifth.
“Since this 225 basis point increase in the cash rate has been fully passed through to mortgage interest rates, it will have reduced the maximum amount borrowers can lend by about 20%,” he said. .
It comes nearly a year after APRA introduced stricter guidelines for service stamps, which are used by banks to assess borrowers’ ability to continue paying their loan at a higher rate.
Previously, banks were required to apply an interest rate cushion of at least 2.5 percentage points to the rates of their loan products. This rate was raised to 3.0 percentage points to ensure the stability of the financial system and in anticipation of future rate hikes.
At the time, the change reduced the maximum loan amount a borrower could take by up to 5%, a difference which Kearns says has been eclipsed by the current round of rate hikes.
“The increase in the cash rate since May has been 225 basis points, and so that has had a much bigger impact on the maximum loan size than the APRA requirement.”
“And because the assessment rate also applies to any existing debt, the decrease in borrowing capacity is even greater for potential borrowers who have existing debt, such as real estate investors.”
Fortunately, it is rare for borrowers to withdraw the maximum amount a bank is willing to lend to them, with banks reporting that such customers make up only about 10% of their loan portfolios.
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“As a result, even if the maximum loan size for all borrowers is reduced by 20% in response to higher interest rates, all new borrowers will not have to take out a 20% smaller loan,” he said. said Kearns.
“For many borrowers, the amount they spend on a new home would decrease only slightly or not at all (partly because their savings to use as a deposit need not decrease with higher interest rates) .”
However, Kearns points out that the rapid rise in interest rates, which is expected to continue until the RBA can bring inflation back within target, also means that new borrowers will make larger repayments on their loans.
“For example, with the 225 basis point increase in the mortgage interest rate – compared to the average mortgage rates before May – the monthly payments on a new loan (principal and interest over 25 years) will be around 25% higher,” he said.
“This increase in mortgage payments may influence how much people want to borrow.”
It’s important to note that this won’t necessarily apply to existing borrowers, many of whom pay above the minimum repayment amount set by their lenders or make regular contributions to their clearing accounts.
Fixed-rate loans also make up a significant share of the residential mortgage market – currently around 35% – and these borrowers will not face increased repayments until their fixed terms expire.
For more information on interest rates and loan trends, visit our home loan statistics page. And if you’re looking for a home loan, visit our home loan comparison page or browse the selection below.
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