Tue Apr 15

Would looser lending rules help more people buy a house – or just put them at risk?

Written by: Andrew Grant, Associate Professor in Finance, University of Sydney

Big promises on housing were at the centre of both major parties’ announcements at the official federal election campaign launches ^[1] on the weekend.

Among the highlights, Labor pledged to build 100,000 new homes and extend a government-guaranteed 5% deposit scheme ^[2] to all first home buyers. The Coalition promised to make interest payments on the first A$650,000 of a mortgage tax-deductible ^[3] for up to five years, for eligible first home buyers purchasing new builds.

Amid this flurry of policies, it’s important we don’t forget another Coalition promise from earlier this month – lowering the 3% mortgage serviceability “buffer”^[4].

Promising to help would-be homebuyers without access to the “bank of mum and dad”, the policy aims to make loans easier to get amid high interest rates and house prices. But it has also reignited debate over lending regulation.

What exactly does this buffer do, and what might we lose by lowering it?

Protecting banks and borrowers

Mortgage buffers are a risk management tool, regulated by the Australian Prudential Regulation Authority (APRA).

When banks assess a home loan, they don’t just check if you can repay it at today’s rate. They test whether you could still afford it if interest rates were higher.

Suppose a borrower in Sydney takes out a mortgage of $780,000 (around the average loan size). At a 6% interest rate, the monthly repayments over 30 years would be about $4,672.

For sale sale sign in front of a block of apartments in Maroubra, Sydney

Borrowers have to demonstrate they could service a mortgage if interest rates went up. Rhett Watson/AAP ^[5]

Under the current serviceability buffer ^[6] – three percentage points – banks assess whether this prospective borrower could still afford repayments if interest rates rose to 9%, which would increase their monthly repayments to around $6,270.

This buffer doesn’t increase the price the borrower actually pays. It simply ensures they have the capacity to service higher repayments if conditions worsen.

The last time mortgage rates were above 9% for an extended period (1996), Peter Dutton was in the Queensland Police Service, the Swans had lost the AFL Grand Final, and Oasis were about to cancel their Australian tour. Could history repeat itself?

Why lower it?

APRA increased the serviceability buffer from 2.5% to 3% in late 2021. But at the time, Australia’s cash rate was very low, at just 0.1%. It’s now 4.1%^[8].

Critics argue ^[9] the buffer has become too restrictive now that rates are higher, locking out first home buyers and those without parental financial help.

The buffer can also act as a barrier to refinancing. Those who qualified for a loan when interest rates were low may no longer meet serviceability requirements under higher rates. Research ^[10] suggests that removing refinancing barriers can reduce loan defaults and support household spending.

The risks

There are good reasons for the measures we have to protect borrowers from future shocks.

Reducing the buffer allows more borrowers to qualify for the same loan. But it also means there’s less built-in protection against future rate rises.

Research ^[11] shows the risk of a borrower defaulting on their mortgage increases sharply when their loan-to-value ratio – the amount borrowed divided by the property’s purchase price – is above 75%, or where a borrower is spending two-thirds of their income on the mortgage.

But buffers also need to be set carefully, ensuring they don’t unnecessarily lock out creditworthy borrowers.

The mortgage serviceability buffer is designed to protect borrowers from sudden financial shocks. doublelee/Shutterstock ^[12]

Help for first home buyers?

When considered together with the Coalition’s additional policies – to allow first home buyers to withdraw up to $50,000 from their superannuation ^[13] for a home deposit and deduct mortgage payments ^[14] from their taxable income – the implications become clearer.

Economic theory suggests that combined, such measures would move more borrowers closer to the margin of affordability.

Many would likely take on the maximum debt they could qualify for, leaving them highly exposed if economic or interest rate conditions deteriorate.

And the very borrowers likely to rely on superannuation withdrawals to fund their deposits are also those with limited savings and potentially high loan-to-value ratios. The borrowers most affected by the barrier are therefore among the most vulnerable to repayment stress.

What about house prices?

There’s the obvious question of what reducing the barriers to borrowing would do to house prices, without a corresponding increase in supply.

Research ^[15] has shown stricter borrower-level constraints are effective in slowing house price growth, especially during periods of rapid credit expansion.

These policies are most effective when targeted toward high-risk borrower groups such as first home buyers or those with high loan-to-valuation ratios.

Some economists ^[16] argue buffers need not be static. Instead, they could be tightened during booms to prevent the housing market overheating, and eased during tougher times to avoid cutting off credit unnecessarily.

One regulatory approach is to change serviceability buffers in line with economic conditions. Mick Tsikas/AAP ^[17]

So, should we lower the buffer?

Serviceability buffers aren’t just bureaucratic hurdles. They are an unseen brake on unsustainable borrowing and a cushion against future shocks.

Borrower constraints don’t only reduce default risk – research shows they also redistribute credit more efficiently ^[18], shifting it away from overheated urban markets and toward lower-risk borrowers.

The first cut to the cash rate in nearly five years has eased ^[19] Australian mortgage stress risk in the short term. With renewed borrowing appetite, the role of buffers becomes even more critical.

Removing them may help more people into homes in the short run, but it comes at the risk of greater pain later.