What is a serviceability buffer and how will the recent rule changes affect you?

If you are in the market to buy a home or in the process of applying for a loan, it is important to understand what a serviceability buffer is and the role it plays in the assessment of your home loan application.

Home loan applications and serviceability buffers

When a bank receives a home loan application, one of the things they assess is your ability to make repayments on the loan. They look at things like your income and living expenses and measure these factors against the size of the loan you have applied for. When evaluating your capacity to service the loan, banks are also required to evaluate whether or not you will be able to continue making repayments in the event of an interest rate hike or if your income and/or living expenses were to change unexpectedly.

To test for these possible circumstances, banks add a serviceability buffer of a specified number of percentage points to your home loan interest rate to determine whether or not you will be able to afford repayments on that same loan at a higher interest rate. In addition to meeting other lending criteria, you must be deemed capable of comfortably making repayments at the higher interest rate before being approved for your desired loan.

The serviceability buffer is a safety net of sorts, for both you and the bank. It is applied to ensure that borrowers are able to service their mortgages under a range of scenarios. It is sometimes referred to as a home loan stress test because the assessor is essentially testing whether or not you will be able to make repayments on the loan at a higher interest rate without experiencing financial stress.

Changes to the serviceability buffer

Previously, banks were expected to add a serviceability buffer of 2.5% to the loan product interest rate when assessing home loan applications. However, on October 6, 2021, the Australian Prudential Regulation Authority (APRA) increased the minimum interest rate serviceability buffer it expects banks to apply to 3%. So now, for a loan product that has an interest rate of 2.72%, banks are required to assess your ability to meet your repayments for that loan at an interest rate of 5.72% (3 percentage points above the loan product interest rate).

Why has APRA increased the interest rate buffer?

APRA explained that they have made this change because “medium-term risks to financial stability are building” and “housing credit growth is increasingly being driven by lending to more marginal and highly indebted borrowers.” * APRA wants to ensure that the financial system remains safe and that banks are lending to borrowers who can afford their loan repayments both now and in the future.

How this change to home loan rules may impact you

The recent increase in serviceability buffer may limit the amount of money you can borrow from a bank. APRA estimates that this change will reduce the maximum borrowing capacity for the typical borrower by around 5 per cent. * But bear in mind, this serviceability buffer only applies to banks. If you are planning on securing finance through a non-bank lender, a 3% serviceability buffer will most likely not be applied as part of your home loan application assessment. If you are looking to apply for a home loan through a bank, even if you already have pre-approval, it is wise to touch base with your mortgage broker before making an offer on a home, to double check how much you can borrow under the new guidelines.

* https://www.apra.gov.au/news-and-publications/apra-increases-banks%E2%80%99-loan-serviceability-expectations-to-counter-rising

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