Banks have been slapped with new limits on interest-only and investor lending as the banking regulator responds to heightened risks of rising housing prices and household indebtedness.
The Australian Prudential Regulation Authority wrote to all banks on Friday, saying it expected them to tighten their lending practices.
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Housing affordability - the options explained
Buying a house is increasingly out of reach for young Australians - Eryk Bagshaw explains the options being considered.
APRA chairman Wayne Byres said the measures would help protect the economy.
"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," he said.
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The key new rules require 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.
It will also force banks to manage lending to investors so as to remain "comfortably" below the previous benchmark of 10 per cent growth.
Banks will also be required to ensure that serviceability metrics – factors that influence a person's ability to pay down a mortgage, such as income and interest rates – are set at "appropriate levels" for current conditions.
They will also need to continue to restrain lending grown in "high-risk" segments.
Mr Byres said lending on interest-only terms represented nearly 40 per cent of residential mortgage lending – a share that is quite 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," he said.
He said individual banks would be slapped with new requirements if they went over the new limits.
"[We] will consider the need to impose additional requirements on a [bank] when the proportion of new lending on interest-only terms exceeds 30 per cent of total new mortgage lending.
Currently all four major banks are well over the new 30 per cent interest-only quota, according to their latest disclosures.
CBA and Westpac stand as the worst offenders, with around 40 per cent of their loan books interest-only, although Morgan Stanley estimates Westpac's is higher at 42 per cent.
NAB and ANZ say 31 and 37 per cent of their loan books are interest-only respectively.
Morgan Stanley figures show CBA is well ahead of the pack in terms of interest-only loans to investors, with 17 per cent of its portfolio in this category.
APRA said banks that were already above the benchmark would have to discuss with the regulator their plans to bring the share of interest-only lending down "as quickly as possible".
APRA warned banks to be prudent about the risk of people's incomes or expenses changing or being impacted by a sudden rate rise, and to factor reasonable buffers into their loan calculations.
It said interest-only loans were risky because they created additional vulnerability due to the risk of "payment shock" – the increase in payments when loans reverted from interest-only to principal and interest – on top of the normal vulnerability of interest rate increases or house price falls that the rest of the market faces.
Treasurer Scott Morrison urged financial regulators last week to crack down harder on loans to real estate investors, saying it was no longer just a question of housing affordability, but "frankly, also an issue about household debt ... and the need to make sure that is well-managed from a financial stability point of view".
Shortly after the speech, three of the four major banks raised interest rates on interest-only and investor loans.
Home prices in Australia's biggest cities have jumped 3.7 per cent since the start of the year, with the proportion of settled auctions on the rise as well.
Sydney house prices have jumped 5.3 per cent since January 1, according to the latest data from CoreLogic.
The median house price in Sydney is now $950,000, while the median unit price hit $740,000. Melbourne's median house price is $710,000 and the unit price at $525,000.
Interest-only loans are when a borrower's repayments cover only the interest on the amount borrowed, for an agreed period.
They are considered riskier than principal and interest loans because once the interest-only period ends, borrowers have to pay both interest and principal in less time. It also results in borrowers paying more interest over the life of the loan.
Mr Byres said APRA would continue to observe conditions in the residential mortgage lending market and might adjust the above measures should circumstances warrant it.
Bell Potter banking analyst TS Lim said it was unclear whether the new limits would be enough to cool the market.
"Maybe APRA will have a look and see if this works, and if not they'll come back with more tools," he said.
He said the response by smaller banks was of greater concern because they were an unknown quantity.
"All the attention is on the major banks. It's very hard to get numbers from the smaller banks."