Reports continue to emerge of investors taking advantage of our ongoing low rate environment, pushing up prices in key areas where returns are most attractive. And in response, regulators are getting antsy once more.
Stories abound of equity laden, mum and dad purchasers raiding the banks’ coffers and pushing potential first time buyers out of inner city markets, particularly in Melbourne and Sydney.
Of course investors are not lamenting the monumental value growth we’ve seen across pockets within both of these major urban hubs in recent times.
Interestingly though, as ‘more fortunate’ property owners celebrate rising house prices (think of all that additional equity), in this instance it seems that cheap credit and exponentially climbing property values are actually costing investors more than most realise.
Side by side comparison
Recently the Trilogy Funding team undertook some professional development, with our brokers honing their servicing calculation prowess to ensure we secure the best possible finance deals and structures for clients.
During the training, two examples were provided to demonstrate how lenders calculate serviceability – the applicant’s capacity to repay a mortgage – in the instance of a loan for investment purposes.
In one case, the applicant with a combined net monthly income of slightly more than $6,000 and total outgoings of $3,380, just passed the bank’s servicing requirements with a $14 surplus, once the applicable HPI and buffer were applied.
The HPI, or Henderson Poverty Index, is a sliding measure used to calculate variable expenses, depending on the applicant’s personal circumstances. In this case, a couple with three dependents whose monthly expenses, based on the applicable HPI, totalled $2,160.
They also had a loan outstanding of $500,000, which attracted a 0.10% buffer of $500.
All of the figures plugged into the servicing calculator in this example were based on lender’s risk measures from back in 2003.
So…a time before the GFC that sent our finance sector into a tailspin of change, and well before the recent regulatory rumbles influencing how the banks are assessing investor borrowers now.
Fast forward to the present day, and even though property values have increased, while interest rates have decreased to record lows, investors are in more of a quandary when it comes to the cost of servicing a loan.
In fact, at today’s figures for HPI and applicable buffer rates, those same applicants from 2003 with a passable surplus of $14 would fail to get across the bank’s serviceability line in 2017.
With an approximate combined income of $6,660 and outgoings of $2,675, the couple with three children would now require a surplus of $4,496 to cover all of their outgoings based on today’s HPI values, and a higher buffer of 0.19% on their existing $500,000 loan.
This means they’d fail the servicing criteria by just over $500.
In a nutshell, the applicants from 2017 are $607 per month better off due to tax cuts and $705 better off each month as a result of lower interest rates.
However, they’re $1,386 worse off due to HPI increases and an additional $450 per month worse off because of a higher buffer rate.
In other words, investors had a greater capacity to service debt 14 years ago in a less risk adverse, higher interest rate environment.
And if industry regulators have their way, serviceability assessment and risk criteria calculations are only set to get tougher.
APRA makes itself clear
Late last year, the Australian Prudential and Regulatory Authority made it clear that authorised deposit institutions should be using a buffer of at least two percentage points when assessing a borrower’s serviceability.
The regulator also suggested the Henderson Poverty Index was an obsolete risk management tool, instead recommending the use of a borrower’s declared living expenses or an appropriately scaled version of the Household Expenditure measure (HEM) or HPI.
In its report APRA states, “Prudent practice is to include a reasonable estimate of housing costs even if a borrower who intends to rely on rental property income to service the loan does not currently report any personal housing expenses (for example, due to living arrangements with friends or relatives).”
It would appear stay at home investors are no longer safe either…
Principal and founder of Digital Finance Analytics Martin North, recently told Australian Broker, “If I were in their (APRA’s) shoes, I would be more worried about the risk in the books than they are. So essentially while they’ve crystallised a lot of things and they’ve made a few changes, to my mind they haven’t fundamentally removed the risk.”
It will be interesting to see what further regulatory interventions come our way in the next few years.
In the meantime, now more than ever, with the servicing goalposts having already moved so drastically, you cannot afford to lack the skills of an experienced mortgage broker on your investment team.
If you would like more information on serviceability criteria and the many differences between lenders and products, why not connect with the team here at Trilogy Funding?
Click here now to talk about how we can help put you on the path to a successful finance structure that works to meet your needs, now and in the future.