18 November 2019
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When good borrowers can't get a fair go.

What's different about this market slow down?

John McGrath
3 July 2018

The key difference between the current market slow down occurring in Sydney and Melbourne and previous market corrections is that this one has been largely engineered through increasing restrictions on residential lending that are compromising buyers’ ability to purchase property.

Previous market slowdowns following a boom have typically been the result of rising interest rates or a change in economic conditions.  Not this one.  Interest rates remain very low with no prospect of a rate rise in sight and the economy is doing well with low unemployment and good growth.

While normal market cooling factors are certainly at play, such as affordability and reduced yields for investors, the biggest factor dampening our market right now is the availability of finance.

Tighter lending policy for residential property began in 2014 and was initially aimed at investors.

APRA imposed a 10% limit on investor credit growth, which meant the banks couldn’t lend to as many investors. Then they told the banks they had to limit new interest-only loans.

This resulted in banks putting a premium on investment interest rates (typically about 0.6%) and interest-only loans (typically 1%), which dampened investors’ enthusiasm. This had the greatest impact in Sydney and Melbourne, where investor activity has been highest in recent years.

Now the banks have tightened their serviceability checks on all borrowers – not just investors.

The way they calculate what a borrower can comfortably afford has changed. There is far more scrutiny around living expenses and debt to income ratios, which makes it tougher for borrowers in our most expensive markets to get approval.

APRA suggested that banks limit loans on “very high” debt to income ratios of six or more. According to CoreLogic figures, the ratio of home values to income in Sydney and Melbourne is 9.3 and eight.

Not only does this mean fewer people are getting loans, but more significantly, the time it’s taking for good borrowers to be approved is blowing out, and this is directly reducing auction competition.

We are hearing many stories of buyers not being able to get loans approved in time to bid.  They see the property in week one, they commence the formal loan approval process and by week four they are still waiting for the rubber stamp. You can’t bid without your finance, so they don’t compete.

This is a problem in a cooling market where many auctions are typically attracting one to three bidders instead of five or more during the boom. It is no doubt contributing to falling clearance rates (although a great price can still be achieved later when buyers are able to participate).

While tighter credit policy is frustrating the marketplace, it is making our banking system stronger. After seeing what can happen when the sector fails, as it did in the US in 2008 triggering the greatest financial crisis of our time, the long-term benefits of a strong system outweigh everything else. 

If you’re currently looking to buy and you’re in a good financial position where securing finance shouldn’t be too difficult, the market presents good opportunities for you today.

There is more stock available for sale, so if your finance takes too long for approval on one house, there will be plenty of others to choose from.  Less competition means you can negotiate harder.

On top of that, you can take advantage of extremely low interest rates when they matter most – in the first five years of your loan when the interest component of repayments far exceeds the principal. 

While we do expect a period of low price growth in Sydney and Melbourne over the next few years, that shouldn’t deter buyers today if you’re buying for the long term. The opportunity to lock in a low interest rate should be far more front of mind than prices falling. History shows they don’t fall much in our big cities (see last week’s column).

Today’s buyers need to keep two things in mind.  Firstly, start the finance process early.  Secondly, with income growth remaining low, it’s important to have a buffer in place so you can afford higher interest rates when they do eventually (and inevitably) go up. 

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