Home loan lenders are being warned by a regulator to carefully monitor the debt serviceability capacity of their customers over the duration of home loans - not just at origination - to ensure borrowers are able to manage the transition to higher interest rates.
The Australian Prudential Regulation Authority’ (APRA) Loan serviceability standards in housing lending report says interest rate hikes are ‘inevitable’ and that a strong focus on debt serviceability is ‘critical’ in the current low interest rate environment.
“In particular, low interest rates can mask debt serviceability assessments, creating opportunities for borrowers to increase their leverage. The resulting growth in demand for housing loans can also put pressure on housing lending standards as ADIs [authorised deposit-taking institutions] compete to maintain or increase their market share,” reads the report.
APRA’s analysis looked at 27 lenders, including major banks, regional banks, credit unions and building societies representing 97% of total home loans as at March, 2013. While the results of the study were generally positive, the regulator says there are a number of areas lenders need to work on, including:
Serviceability assessments: “It is important for ADIs to ensure that borrowers approved at the limits of NIS or DSR models can continue to service their loans in the face of even modest adverse changes in circumstances. Hence, APRA expects these models to contain appropriate interest rate buffers and/or margins on living expenses when used to make serviceability assessments.”
Interest risk buffers: “APRA would expect ADIs to use an interest rate floor, based on the average mortgage interest rate over an appropriately long time period, being at least one cycle in interest rates, in their serviceability assessment.”
Living expenses: “All ADIs surveyed used either the Household Expenditure Measure (HEM) or the Henderson Poverty Index (HPI)…Their wide use reflects their simplicity in application but they do not necessarily reflect an applicant’s actual living expenses, which can be considerably higher…APRA would highlight two areas for improvement. One is to add a margin linked to the borrower’s income to the relevant index. The other is to update the HEM or HPI used in loan calculators on a frequent basis, particularly given that updated figures for these indices are published each quarter.”
Verification of income and other debt obligations: The majority of ADIs ahd detailed policies requiring a borrower’s employment and other income sources to be verified against third-party evidence. However, it was not common practice to extend this to the verification of a borrower’s other declared debt agreements, unless the borrower was refinancing. Moreover, there was no indication that ADIs had appropriate policies and procedures for ensuring that borrowers do not have undeclared debt obligations.”