Another home loan crackdown is looming. Here’s what it might look like

The Treasurer has given the strongest indication yet that a home loan crackdown is looming, confirming that surging house prices were a key topic of discussion at a regulators’ meeting on Friday.

The typical Australian home has seen its value climb more than 18 per cent over the past year, with some cities and many regional areas seeing even larger price jumps.

Fuelling the rise in prices has been an increase in debt, as record-low interest rates have made larger loans more affordable.

The total value of monthly home loan approvals, excluding the refinancing of existing loans, jumped by more than two-thirds over the past year.

Now the architects of the latest housing boom — the Reserve Bank, through record-low interest rates; the banking regulator APRA, through looser lending standards; and the federal government, through its HomeBuilder stimulus scheme — have met to discuss what to do about it.

“Last Friday, I joined the Council of Financial Regulators to discuss a range of issues including the state of the housing market which is a particular focus for both APRA and the RBA,” Treasurer Josh Frydenberg told the ABC in a statement.

“Carefully targeted and timely adjustments are sometimes necessary. There are a range of tools available to APRA to deliver this outcome.”

Mr Frydenberg noted that the early stages of this boom were skewed towards people buying a home to live in themselves.

“A positive feature of this housing cycle compared to that of the last is a higher proportion of first home buyers and owner-occupiers entering the market,” he observed.

“With Australia’s economy well positioned to strongly recover as restrictions ease, it is important to continually assess the appropriateness of our macroprudential settings.”

Aside from the economic recovery, however, a change in the composition of property buyers during 2021 also seems to have policymakers concerned and considering regulatory action soon.

While the borrowing boom was originally led by owner-occupiers, lately it has been investors driving the growth in new loans.

The most recent July figures showed new loans to landlords had risen 1.8 per cent over the month (versus a fall in owner-occupier lending) and almost doubled in value from a year earlier.

What is to be done?

So what are the “macroprudential settings” the Treasurer refers to, and how might they be changed?

In simple terms, they are the rules that the banking regulator APRA sets for the financial institutions it oversees about how much money they can lend and who they can loan it to.

The last time Australia had a big property boom between 2012-17, mainly concentrated in Sydney and Melbourne, APRA specifically targeted the property investor segment driving the market.

The first measure introduced (announced in late-2014) was a 10 per cent cap on annual investor lending growth, along with a move towards using a bigger buffer when assessing loan applicants to ensure they could cope with interest rate rises.

The second measure (in March 2017) was a 30 per cent cap on new interest-only lending as a proportion of all new home loans.

But CoreLogic’s head of research, Eliza Owen, along with most other analysts, expects different measures to be adopted this time.

“Given investors still proportionally make up a low proportion of housing finance (29.1 per cent, below the decade average of 35.1 per cent), it makes sense that the nature of macroprudential regulation through the current cycle would be different to what was observed through the previous cycle of 2012-2017, when investor participation peaked at 45.2 per cent,” she told ABC News.

Most analysts expect that this time, APRA will target debt-to-income ratios, probably by limiting the proportion of loans that can be made above six times an applicant’s household income.

So, for example, if you earned $70,000 and your partner earned $30,000 then it would become much harder to get a home loan for more than $600,000.

This is something the Reserve Bank of New Zealand (RBNZ)is actively considering, in conjunction with limits on low-deposit home loans and government action to end negative gearing introduced earlier this year.

The International Monetary Fund last week urged Australia to make a similar move.

“Macroprudential policy should be tightened and lending standards closely monitored,” it noted in its most recent country report.

“Options include increasing interest serviceability buffers and instituting portfolio restrictions on debt-to-income and loan-to-value ratios.”

A debt-to-income limit has also been hinted at as a likely option by financial policymakers themselves.

“Unlike in 2014 and 2017, the concerns this time are not specific types of lending such as investor or interest-only lending. So the tools used at that time are not really appropriate at this time,” said Reserve Bank assistant governor Michelle Bullock in a speech last week.

“This suggests that if there were to be a need for so-called macroprudential tools to address rising risks, they should be targeted at the risks arising from highly indebted borrowers.

Why are regulators likely to step in?

You may think it is all about slowing runaway house price growth, but ANZ senior economist Felicity Emmett said it is not.

“Those sorts of house price rises tend to mean that we see big increases in household debt,” she explained.

She said that a move to crack down on high debt-to-income ratio lending is not even primarily to protect the banks from potential defaults, like those we saw in US sub-prime mortgages that led to the global financial crisis, but rather to safeguard the economy.

“The issue for the regulators is not about banking stability, but is about macro stability in the event of an economic shock, when households are more likely to pull back sharply on spending if they are heavily indebted,” she added.

The Reserve Bank’s own research has shown that more indebted households are likely to spend less, even in the absence of an economic downturn.

An alternative way to reduce risky borrowing, and as a result put downward pressure on house prices, would be to raise interest rates.

But Ms Emmett said that is not an option for the Reserve Bank while the economy is struggling to recover from the latest COVID-19 outbreaks and lockdowns.

“Interest rates need to stay low to support economic growth, so they really do need to rely on these macroprudential policies,” she explained.

What will macroprudential rules do to house prices?

It is impossible to be sure exactly what effect a debt-to-income limit would have on Australian house prices.

Ms Owen said history might offer some clues.

“Looking to the past, 2012-2017 saw extended periods of strong dwelling value growth amid falling interest rates, and macroprudential measures probably had the effect of cooling housing market conditions indirectly through tighter financing conditions,” she noted.

To illustrate the point, the two large markets that had the biggest booms — Sydney and Melbourne — had price growth of roughly 75 and 73 per cent respectively.

CoreLogic’s analysis shows that the 10 per cent speed limit on investor lending growth may have knocked 3.4 per cent off the Sydney market and next to nothing from Melbourne prices.

The 30 per cent speed limit on interest-only loans (and a general tightening of mortgage approval standards during the banking royal commission) saw prices fall around 15 per cent in Sydney and 14 per cent in Melbourne between 2017-19.

Ms Owen said the effects might be larger given the relatively rapid upswing in home prices Australia has experienced over the past year, but it would depend on what specific rules end up being adopted.

At the very least, a lending crackdown would take some heat out of the current price rises.

“Suffice to say a change to credit conditions would very likely change the housing market dynamics we are seeing at the moment,” Ms Owen added.

When might this happen?

The Council of Financial Regulators releases its latest quarterly statement on Wednesday, but it is not expected to announce any new macroprudential rules immediately.

Analysts will be looking for discussion in the statement about the kind of rules that might be introduced and further hints about a timeline.

But Ms Emmett said ANZ has been forecasting some sort of macroprudential policy response since March this year, and she would be “surprised” not to see action over the next few months.

“I think it is likely we get something before the end of the year,” she said.