Borrowing capacity reduction could rise to $380,000 if interest rates are raised to 3.6 percent by next April, as predicted by Westpac Bank and Morgan Stanley. The table below illustrates the declining lending capacity.
Six consecutive rate hikes since May by the Reserve Bank of Australia have lifted interest rates from 0.25 percent to 2.60 percent.
Borrowers are also being pressured by Australia’s Prudential Regulation Authority (APRA) mandated 3 per cent operational buffer, which is used by lenders to assess capacity to deal with rising costs.
As part of the APRA stress test, each new home loan applicant must demonstrate that they can afford monthly repayments at 3 percentage points more than they are asking for, or the bank’s preset minimum interest rate (whichever is higher). A minimum interest rate is the minimum interest rate that will be charged to a borrower.
This test becomes harder to pass as interest rates rise.
Many lenders are deliberately delaying rate hikes by weeks to ensure borrowers have time to qualify for lower rates, banking specialists say.
For example, Unloan Home Loans, a digital lender owned by CBA, the country’s largest lender, is waiting until mid-November to raise its interest rates after the RBA’s October hike in cash rates by 25 percentage points.
What to do
Buyers are advised to offset the risk of deals failing by including a financing clause, which gives borrowers time to arrange a loan for the property or to terminate the contract if they cannot obtain financing.
It can protect them from losing their security deposit or being sued by the seller for damages if the loan is declined.
A standard clause includes the lender’s name, loan amount, approval date, loan term, and interest rate. It typically takes seven to 21 days to renegotiate a loan.
However, they have limitations and borrowers are advised to seek legal advice.
Patrick Bright, a buyer’s agent, says they are “unacceptable to sellers” and claims they are a “prison-free card” for buyers who agree to buy a property and then change their mind, often for unfounded reasons to do finance.
“It means you’re negotiating to get a property over the line just so the buyer can walk out with no qualms,” says Bright. “It means you may lose the next person who would have bid for the property and leave other potential buyers with a negative impression of the property.”
He insists that clients have documented proof of a recent pre-approved home loan offer.
Cate Bakos, also a buyer’s agent, says rapidly rising interest rates mean many buyers are struggling to understand their maximum borrowing capacity.
Bakos says, “This ambiguity means they are flying blind. They have a rough idea of what their credit capacity was last month, and this month it’s a guess.”
“They are nervous about signing something unconditional and are asking for a finance clause to avoid the risk of losing their bail and being sued for damages.”
But Melissa Inglis, a partner at Rose Litigation Lawyers, warns that the courts are cracking down on borrowers who try to use the clauses as loopholes.
“Sellers are allowed to request evidence of the reasonable steps taken if a buyer cancels. A buyer can lose their deposit and be liable for damages if they have not taken reasonable steps to secure financing to complete the purchase,” says Inglis.
A recent case involved a buyer who was found to have breached the clause by designating a bank in her finance clause that she did not pursue and then not obtaining credit through an alternative lender.
The court ruled that she had not taken all reasonable steps to obtain funding, forfeited her bail and held her liable for damages and costs of the proceedings.
Inglis says, “When entering into a contract to buy a home, make sure the terms of the contract are correct, avoid nominating a particular lender, and have an attorney review it before signing it.”
RateCity Research Director Sally Tindall says: “Six consecutive RBA hikes have already caused carnage in the budgets of many buyers across the country. If rate hikes continue as forecast, people’s funds could shrink even further, sending many buyers back to the drawing board.”
Tindall recommends those planning a home loan to carefully consider how much debt they’re taking on and factor in at least another percentage point of rate hikes over the next six months, and possibly many more over the longer term.
“Banks test people’s finances to make sure they can cope with rising interest rates, but it’s worth checking the numbers for yourself,” she says. “They may have a very different interpretation of what is affordable.”