New Assessment Rate for Home Loans
The guidelines used to assess home loans have changed. Because of record low interest rates, APRA will now allow lenders to set their own assessment rate. The good news is, some Australian borrowers will be able to significantly increase their borrowing power.
What has happened to the assessment rate?
From July 2019, banks and lenders will be using the new 2.5% buffer rate and are permitted by APRA to set their own assessment rate. Most lenders are setting a new ‘floor’, or serviceability, rate of around 5.75%.
Originally, lenders had to use a buffer rate of at least 2% and had to assess at a minimum of 7%.
What were the APRA changes to mortgage lending?
Since 2014, lenders were required by the Australian Prudential Regulation Authority (APRA) to service a borrower’s loan amount using the higher of either (i) an interest rate floor at 7%, or (ii) a 2% buffer over the loan’s interest rate. Many lenders chose to use a rate of 7.25% or higher.
In June of 2019, there was a proposal for a slight relaxation of policy. The change was suggested because the guidelines set 5 years prior were no longer feasible given record low interest rates.
A month later, APRA finalised changes to guidance on residential mortgage lending. They adjusted the buffer rate from 2% to 2.5%. Moreover, each lender will now set their own bank assessment rate.
What is an assessment rate?
An assessment rate, also sometimes known as a buffer, floor, or serviceability rate, is applied to existing and proposed lending to determine a new loan applicant’s ability to meet repayments if interest rates rise.
In brief, it’s essentially a ‘stress test’ to make sure you are financially capable for the loan.
New Major Banks Serviceability Guidelines as of July 2019
Lenders, including the big four, will be deciding their own serviceability floor rates. While changes are slowly rolling out, most lenders are going with a minimum floor rate of around 5.75%.
ANZ and Westpac were the first to announce their new assessment rates to be respectively 5.50% and 5.75%.
July 22: CBA’s new serviceability floor has been lowered to 5.75%
July 23: NAB has become the final major to announce changes, lowering it’s floor to 5.5%, effective from 5 August.
If your application has yet to be formally approved you will be assessed under the new floor and buffer rates. On the other hand, any applications formally approved before a lender has set their own guidelines will retain existing benchmarks.
How does loan serviceability work?
Loan serviceability is a calculation of a borrower’s ability to meet repayments, based on loan amount, income, and expenses. In addition, banks will apply a buffer to the original interest rate as part of their assessment of the loan. This is used to see if the borrower can afford the home loan if rates were to change. Everyone’s situation is different, but this should provide a general idea of the process.
Let’s say you were taking out a loan at an interest rate of 3.75% under the original APRA guidelines. Because the original buffer rate (of 2%) puts the assessment rate well below the minimum, your lender might have assessed your ability to meet mortgage repayments based on an interest rate of 7.25%.
With the new serviceability guidelines, you will be financially tested at 6.25%. The lender adds the buffer of 2.5% to your loan of 3.75%.
For some, this reduction (of 1% in this example) could considerably improve the chances of being approved for a home loan.
How does the new assessment rate affect borrowing power?
All in all, given the back-to-back rate cuts by the RBA and changes to the APRA guidelines, the potential borrowing power for Australians has risen.
With the help of our borrowing power calculator, we will use the serviceability rates from the previous example, 7.25% and 6.25%, to compare how much you could borrow under the new changes.
With this in mind, let’s assume that you are a single borrower with an income of $80,000 p.a. with living expenses of $2,400 and no dependents. The loan term is 30 years.
You could borrow up to $518,000 at an assessment rate of 7.25% under the original guidelines.
With a new assessment rate of 6.25% under the same conditions, you could potentially borrow an extra $49,000, totally up to $567,000.
Does this change strict lending criteria?
Many people who narrowly missed out on approval should now have a better chance of borrowing with loan providers beginning to follow the proposed changes. The other upside is some borrowers might be able to add to their borrowing capacity.
That being the case, lenders will not be making it any easier in their overall assessment of you meeting eligibility criteria. The increased level of information required, questions asked, and scrutiny of expenses will remain.
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Although the low interest rate environment will remain for some time, rates will certainly rise during a 25- or 30-year mortgage. Consider your own circumstances and budget before rushing for a new loan. Borrow what you need and can afford.
If you’d like help, we’re happy to lend a hand and do a free assessment of your circumstances.Free Home Loan Assessment
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