If you’re in the hunt for a home loan, you may have noticed the market has rarely been as varied as it is today. The simpler days of the First Home Owners Grant under Howard are long behind us.
For one, figuring out whether you’re going to be an investor or owner occupier is easier said than done. It may sound strange, but it’s a question that growing numbers of investors have been asking themselves of late. In this day and age, with stricter investment lending standards, it’s become more commonplace.
At the same time, it matters now more than ever what you bring to the table as a borrower. Banks are favouring those who can come equipped with heftier deposits. And there’s a good reason for that.
You may remember that lenders targeted investors last year by raising interest rates. They did so on two separate occasions. And it came as a response to APRA regulations. The prudential regulator forced banks to limit investment lending growth to 10%.
To compensate for this loss of business, banks turned their attention to owner occupiers. There was even a period where owner occupier lending was outpacing investment lending. So much so that banks eventually raised home loan rates for owner occupiers too.
But we’re now seeing yet another crack appear in the home loan market. Only this time, it’s not a split between investor and owner occupier lending. What we’re seeing taking place is a divide in how lenders treat owner occupiers.
Banks have started offering lower home loan rates to borrowers that have larger deposits. The big winners are those individuals who can put down at least a 20% deposit. The losers are those that can’t. Who may even find themselves paying higher rates than they would otherwise.
Up to now, deposits mattered in determining how much a borrower had to pay back over the course of a loan term. It held little importance in deciding what rates banks slugged borrowers with. For example, say you had a $100,000 deposit. You wanted to borrow $500,000 over 30 years. Compared to someone with a $40,000 deposit, your monthly repayments would be much lower. But the interest rate of those loans would remain the same. The difference now is that these changes are affecting the rates banks offer to customers.
So banks have become far more selective in choosing to whom, and how, they lend. As the Sydney Morning Herald reports:
‘RateCity analyst Peter Arnold said the average interest rates being offered to owner-occupiers with a 20% deposit have dipped by 0.07% since June, to 4.35%.
‘“There’s a lot more variation in the market, with tiered pricing,” Mr Arnold said. “These borrowers are basically paying less than they were back in June.”
‘In contrast, other types of borrowers are offered higher interest rates than they were six months ago, RateCity found. Its figures cover the rates banks are advertising for new customers, rather than what banks charge their existing borrowers.
‘For property investors with deposits of less than 20%, the average rate on offer has increased to 4.9% from 4.68%, it says. This means that property investors, especially those with smaller deposits, are being charged interest rates as much as 0.55% than owner-occupiers.
‘Interest rates offered to owner-occupiers with deposits of less than 20% have also edged up, albeit by only 0.03%, to 4.71%.’
To be fair, deposits still matter much more for investors. But the fact that banks are applying such measures to owner occupiers is telling. It proves that banks are trying to win customers in such a competitive market. But it also shows they’re prioritising lower risk borrowers.
What lenders are now doing in this owner occupier market might leave you feeling miffed. After all, should double standards apply to borrowers who just want to live in their homes? At any other time in the past few decades, the answer would be no. But the more you think about it, the more it makes a certain degree of sense.
Everyone’s aware of the uncertainty surrounding the Australian economy. Property values have shot up beyond the means of most households. Wages are barely growing at 2% (some six times lower than median national house prices). Throw in China’s slowdown, weak commodity prices, and general market volatility, and there’s real cause for concern.
One of the key reasons we’ve avoided a recession up to now is down to the stability of the housing sector. We need to take care to ensure that it remains that way. One of the easiest ways of doing this is to make sure banks lend sensibly.
In order for that to happen, banks should take things up a notch. They should apply even stricter lending standards for all home loans. At the least, lenders should take the same approach to owner occupiers that they have with investors. A 0.03% rate hike for owners with less than a 20% deposit is a start, but it’s a measly one. They can raise rates a lot more than this.
All groans aside, tailoring loan terms to individual borrowers makes sense. It not only helps put the brakes on the rising house prices across the market. But it should also ease concerns about the impact of both a housing crash and a potential recession.
Banks are lowering home loan risk, but want more business
Of course, banks aren’t doing any of this because they care about the state of the housing market. The reason why these measures are in place is to benefit banks first. Tailoring home loans is primarily a way of attracting new customers. That’s how the banks see it, anyway. If regulators won’t let them expand investment loan books, they’ll look elsewhere.
But if banks want more business from owner occupiers, why not lower home loan rates for all owner occupiers? Well, banks aren’t stupid. They still have balance sheets and reserve ratio requirements to think about. They know regulators would be all over them if they eased lending standards too much.
From a lenders point of view, it makes sense to tailor interest rates on a case by case basis. It’s not only a way of attracting new customers they might otherwise have lost to competition. It’s also a way of making them look like they’re being prudent with their lending. And, if nothing else, it should ensure more stability across banks’ home loan balance sheets.
Banks know, better than anyone, that low risk borrowers are the best kind. They’re the least likely to default on loans. Not only because they’re borrowing (and repaying) less. But because larger deposits suggest they’re in a strong financial position.
Why banks should raise the stakes in raising lending standards
The only problem is these lending measures still don’t go far enough. At the least, banks should become even more rigorous in assessing borrowers.
Everything from deposits, to credit histories, to debts, to income histories should count. Yes, banks already look at all these things. But every single factor should have a bigger bearing on a borrowers’ worthiness. That may seem draconian and unfair. But the benefits should outweigh the downsides in the long run.
Whether banks would be willing to do this is another matter altogether. After all, they’re tailoring home loan rates as a way of winning more business, not less. Nor are they too concerned about how their lending distorts the housing market. So it may be that we need more regulatory oversight for lenders to start thinking this way.
Either way, one thing is clear. Making it even harder to qualify for loans would ease pressures on the housing market. And it should help lower house prices in the long run. That would also help with housing affordability. In turn, it could also result in lower lending requirements in the future.
In any case, with the issues plaguing the Australian economy, the path ahead is clear. Home loan lending standards must become even more stringent. At present, the differences between newly tailored owner occupier loans remains fairly small. Yet if we’re serious about keeping some semblance of stability in the market, there’s scope for banks to take things much further.
Until then, house prices are likely to keep growing, albeit at a slower pace than last year. The Commonwealth Bank recently forecast growth of up to 2% in Sydney and Melbourne this year.
The Daily Reckoning’s property expert, Phillip J. Anderson, agrees that house prices have yet to hit their peak. In fact, he says we’re heading into another boom that could last a decade.
Phil’s 20 years of experience as a property analyst and advisor has given him a keen sense for where the property market is, and where it’s going. He predicted the housing market crash in 2008. And he went against the mainstream in 2009, saying house prices would continue to this decade.
He was right on both accounts.
In a free report ‘Why Australian Property is on the Verge of a Decade Long Boom’, Phil guides you through this coming decade. He’ll show you the right time to buy property at its cheapest, and how you can use this to time your investments. To find out how to download his free report, click here.
Junior Analyst, The Daily Reckoning