A widening gap between house prices and incomes could spell danger for borrowers

Brendon Thorne/Getty Images
  • Australian home prices are falling, led by Sydney and Melbourne.
  • Tighter lending restrictions have played a major role in the recent slowdown.
  • Macroprudential restrictions appear to be moving towards limiting loans to highly-indebted and highly-leveraged borrowers, something that could have implications for prices in Australia’s most expensive housing markets.

Australian home prices are starting to fall after years of relentless – sometimes rampant – growth.

Much of the recent weakness reflects declines in Sydney and Melbourne.

Though some of that recent weakness can be put down to factors such as affordability constraints, higher property listings as well as an overall souring in sentiment towards the outlook for capital growth, it’s clear that tighter lending restrictions have also played a part.

Even with official interest rates sitting at the lowest level on record, something that traditionally would lead to further price gains, macroprudential restrictions have left their mark.

After introducing a 10% annual cap on investor housing credit growth in late 2014, something subsequently removed for some lenders, APRA, Australia’s banking regulator, followed up in March last year with restrictions on interest-only mortgage lending, limiting fixed-interest facilities to 30% of new loans.

Like the cap on investor credit growth before it, this has seen a steep decline in the value of investor housing loans, a key factor that contributed to price declines in Sydney and Melbourne, two markets traditionally been favoured by investors.

Even with recent success, it appears that APRA’s macroprudential restrictions are continuing to involve.

When announcing the removal of the investor lending cap last month, APRA said that it expects Australian authorised deposit-taking institutions (ADIs) to “develop internal portfolio limits on the proportion of new lending at very high debt-to-income levels, and policy limits on maximum debt-to-income levels for individual borrowers”.

“This provides a simple backstop to complement the more complex and detailed serviceability calculation for individual borrowers, and takes into account the total borrowings of an applicant, rather than just the specific loan being applied for,” APRA said.

In other words: restrict lending to those seeking loans significantly larger than their incomes, or lending to those already carrying a significant amount of debt.

At a time when housing credit growth is already slowing on the back of weaker investor lending, some analysts believe limiting lending to these borrowers could lead to an even faster deceleration in housing credit growth, as well as further price declines.

They would, after all, limit a large proportion of borrowers the amount they can be lent.

These charts from CoreLogic help explain why it could lead to further weakness in both home loan lending and prices.

Using gross household income data modelled by the Australian National University (ANU) Centre for Social Research and Methods, it provides a rough guide on the potential impact that limiting debt-to-income ratios to six times income could be.

It shows the median dwelling price for individual capital cities, along with the maximum amount that could be lent with a debt restricted to six times earnings.

Importantly, it does not take into consideration deposit size, something that would normally help boost what a potential property buyer could afford.

The first shows the median Sydney house price overlaid against the maximum borrowing potential.

CoreLogic

And here’s a similar chart, only for Sydney units.

CoreLogic

While only a rough guide (we emphasise that point), it’s clear that median prices, particularly for houses,are currently well above maximum borrowing capacity at six times gross median annual income,.

It’s a similar story for Melbourne house prices, as seen in the chart below.

CoreLogic

Cameron Kusher, Research Analyst at CoreLogic, says it demonstrates what income and debt-based lending restrictions could do to property prices in Australia’s most expensive markets.

“Of course median values don’t tell the whole story, as many properties are values below that values as there are above. However, it is valuable in providing a guide for what impact limiting high loan to income lending would have,” he says.

“Were hard limits on loan-to-income (LTI) to be implemented, it would have a much bigger impact on Sydney and Melbourne than any other areas of the country.

“Any limit would still have some impact on households outside of Sydney and Melbourne, not to mention those that are purchasing properties additional to their principal place of resident.”

While, at this point, there has been no hard restrictions announced on high LVI lending, Kusher says APRA is clearly trying to steer ADIs away from overly-leveraged borrowers.

“[It] is clear that APRA would like to see high LTI lending dialled back and that will have an impact on some borrowers, particularly those purchasing more expensive properties and/or those that have multiple properties,” he says.

In a note released late last month, UBS described APRA’s move to limit mortgage lending based on debt and income levels as macroprudential “Phase 3”, warning it “raises the risk of a material negative impact on housing and the economy”.

JP Morgan economists conveyed a similar view, noting that “slower credit growth, along with limited capacity for further falls in the saving rate, will be a significant headwind for consumption in coming years”.

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