Expert Advice with Simon Buckingham
On July 5th, banking regulator APRA officially abolished a significant lending restriction that had been around for the last 4 years... the requirement that banks had to test your ability to repay a loan at a minimum 7% interest rate.
This restriction had materially limited the borrowing power of investors and home buyers - lowering the average person's borrowing capacity by 10-20%.
It's no surprise that this led to a fall in property prices in many parts of the country, especially when combined with market uncertainties leading into the recent Federal Election.
This has all CHANGED...
Abolishing the 7% test is a MAJOR change - probably the biggest positive change affecting property investors and home buyers in the past 4 years.
It's likely to have a bigger impact on the market than the two interest rate cuts from the last two months - because it increases the effectiveness of lower interest rates.
And it's an even bigger positive change than the removal of uncertainties around property taxes, now that changes to negative gearing and CGT are off the table with the Coalition winning the election.
What has changed, and why:
Back in 2014, APRA imposed a restriction on the banks requiring lenders to test a borrower's ability to afford a loan at a theoretical minimum interest rate of either 7% or 2% above the actual interest rate of the loan, whichever was the higher figure.
The aim of this was to ensure that borrowers could afford higher repayments in the event that interest rates went up in the future.
In practice, most of the big banks applied a 7.25% minimum.
If you've been reading my newsletters for a while, you'll recall I've argued for the past couple of years that the 7% test was out of step with interest rate realities.
Finally the regulators have woken up to this fact. On July 5th APRA officially announced the abolition of the 7% test, acknowledging that it was no longer appropriate in a low interest rate environment, where the trend in rates is actually down rather than up.
Lenders can now set their own minimum interest rate "threshold" for testing what a borrower can afford, as long as they ensure the borrower would be able to afford repayments at an interest rate at least 2.5% higher than the actual lending rate.
How has YOUR bank responded?
Banks make their money by lending, and so it's no surprise they've acted quickly to turn the "lending tap" back on - now they've been given permission to relax the test.
At the time of writing, here's how the big banks and others have adjusted their minimum interest rate "threshold" for assessing loan applications:
Westpac, CBA, Bendigo Bank, Adelaide Bank, Bank of Melbourne, Bank SA, St George Bank, and Heritage Bank have reduced their minimum interest rate test from around 7.25% (or higher) to 5.75%.
ANZ , the NAB, Teachers Mutual Bank, Unibank, Firefighters Mutual Bank, and Health Professionals Bank have all gone a step further and cut their minimum interest rate test to 5.5%.
Macquarie and Suncorp have undercut the majors with an even lower minimum test of only 5.3%.
Bank of Sydney and MyState Bank didn't go quite as far as other lenders, only lowering their tests to 5.85% and 6.2% respectively.
How the new lending test works...
Remember, the way this works is that a borrower must be able to demonstrate an ability to repay the loan at the "threshold" rate, OR 2.5% above the actual loan interest rate - WHICHEVER IS HIGHER.
So the "threshold" rate really only gets used if the actual interest rate on the loan is more than 2.5% below the "threshold" rate.
Otherwise you'll just be tested on your ability to afford a loan at your actual interest rate plus 2.5%.
What this means for YOU:
With recent cuts in interest rates, it's not hard to find investment loans with actual interest rates below 3.5% - and there are lower rates on the horizon!
What this means is that if you're taking out a loan on an actual interest rate of 3.5%, most lenders will now only test your ability to afford the loan at a "buffered" rate of 6% (being 3.5% plus the mandatory buffer of 2.5%).
This translates to around a 12-14% increase in borrowing power compared to what you may have been able to borrow under the old rules.
For a borrower on an average income with "average" living expenses, that's potentially over sixty thousand in additional borrowing ability!
The combination of this change and lower interest rates has essentially REVERSED the drop in average borrowing power from the last 4 years.
And if interest rates fall further (as they are likely to do over the coming months), the resulting increase in your borrowing power could go as high as 18% or more!
It goes without saying then that now is the time to get an updated assessment of your borrowing capacity. Any existing assessments or pre-approvals will now be out-of date, as they would have been done under the old loan assessment criteria.
Get in touch with your broker and see how the amount you can potentially borrow may have changed!
Big changes mean BIG OPPORTUNITIES for smart investors!
The changes in lending - coming on the back of interest rate cuts, the election result, tax cuts and big spending on infrastructure projects by the government - create an environment primed for property values to rise in many parts of the country over the coming months.
Latest research shows that these changes are already having a positive impact on market trends, with auction clearance rates on the east coast back up over 70%, and buyers back in the market.
Property values in Sydney and Melbourne, which had fallen by around 10% in aggregate over the past 2 years, appear to have stabilised lately and are already showing signs of lifting again in many suburbs.
Other centres are mixed, with Adelaide, Brisbane and Perth values currently still drifting down at present, but also likely to show some recovery over the coming months.
Has the property market "bottomed-out"...?
...If it has, then this could be the best time to get in and "cherry pick" great property deals - before prices take off again.
Educated, prepared investors stand to make substantial profits... while those who sit by, paralysed by uncertainty, will look back in a couple of years wondering why they didn't act as the market changed.
So how are YOU going to manage the NEXT PHASE in the property market?
For more market insights and practical strategies, tips and techniques for investing successfully in today's changing property market, join me at one of our upcoming property investor briefings.
Simon Buckingham is Director of Results Mentoring and a highly experienced investor. Simon has been investing in property for over 15 years using a broad range of strategies including positive cash flow, renovations, property development and commercial properties, both within Australia and overseas.
Holding university degrees in Commerce and Law, and with over 10 years' experience as a business consultant, Simon turned his back on corporate life forever following the births of his two children and now spends his time investing, developing property, supporting multiple charities, and building businesses - while teaching others how they can do the same. He has personally coached hundreds of investors in techniques that can be used to profit from property in any market conditions, regularly facilitates public workshops and provides other free resources for property investors through ResultsMentoring.com, and has presented to thousands of people at property conferences and seminars around Australia and New Zealand.
Simon writes the highly regarded Sophisticated Property Investor e-newsletter and his opinions on the property market and real-world investing strategies have featured in Your Investment Property magazine, Smart Property Investment, Channel7 News at 6, Kevin Turner's Real Estate Talk, and Property Observer. He is co-author of the critically acclaimed property book The Real Deal: Property Invest Your Way to Financial Freedom, and a founding Mentor in Australia's award-winning personal mentoring service for property investors: the RESULTS Mentoring Program.
Disclaimer: while due care is taken, the viewpoints expressed by contributors do not necessarily reflect the opinions of Your Investment Property.