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May 30, 2018

What Would A Loan To Income Cap Of 6 Times Look Like?

Cameron Kusher | CoreLogic RP Data

The recent Royal Commission on Banking has shone the spotlight on responsible lending over recent years and turned our attention to what the future may look like…

In a recent letter to all Australian authorised deposit-taking institutions (ADIs) entitled ‘Embedding Sound Residential Lending Practices,’ the Australian Prudential Regulation Authority (APRA) indicated that lenders need to limit lending at very high debt to income levels.  The actual wording of the comment was, “APRA expects ADIs to commit to developing internal risk appetite limits on the proportion of new lending at very high debt to income levels (where debt is greater than 6 times a borrower’s income), and policy limits on maximum debt to income levels for individual borrowers”.

This doesn’t suggest that there is any hard limit on loan to income (LTI) ratios above 6 times but it does suggest that there will be less appetite for mortgages which are in excess of 6 times incomes.

Utilising gross household income data that has been modelled by the Australian National University (ANU) Centre for Social Research and Methods we can take a look across the individual capital cities at what the impact of limiting debt to income ratios to six times would be.  The following charts look at annual gross household incomes with a comparison to median values at the end of 2017.  Incomes are elevated six times for comparison to median prices. 

For Adelaide the news is positive
The typical household in Adelaide can still afford the median house and unit.  As at December 2017 the median house cost $458,806 and the median unit $331,325.  Based on the median gross household income of $1,277/week someone on this income could borrow up to $498,161.

On the Eastern Seaboard… it’s a little more bleak
In Sydney the median household can’t afford the median house or unit if there was a LTI limit of 6 times.

Six times the median gross household income in Sydney is calculated at $688,764.  The median house value in Sydney is $1,058,306 and the median unit value is $774,124.  What this means is that if a buyer wanted to purchase the median house under this scenario they would need a deposit of $369,542 and for the median unit they’d need a deposit of $85,360.

When it comes to Melbourne, the median household can’t afford the median house. 

At the end of 2017, Melbourne’s median house value was $832,735 and the median unit value was $574,052.  At the same time, the median gross household income was $1,553/week with six times this annual income was recorded at $605,787.  Based on these figures, at 6 times income, borrowers in Melbourne can still afford the median unit but would need a deposit of $226,948 to be able to borrow below six times their income for the median house.

Were hard limits on LTI to be implemented it would have a much bigger impact on Sydney and Melbourne than any other areas of the country.  Any limit would still have some impact on households outside of Sydney and Melbourne, not to mention those that are purchasing properties additional to their principal place of resident.

Unlike Sydney and Melbourne, households on the median income in Brisbane can still afford to borrow enough for the median valued house or unit.  The borrowing power for someone on the median income is $608,830 which is lower than both the median house ($531,248) and median unit ($383,752) value.

Of course median values don’t tell the whole story, as many properties are valued below as there are above however, it is valuable in providing a guide for what impact limiting high loan to income lending would have. 

Also keep in mind that these figures are only looking at a single scenario.  In most instances a lender will not allow a borrower to borrow 100% of the value of a property and if a borrower has a deposit of less than 20% they will need to pay lenders mortgage insurance (LMI).

So far there is no indication of a hard cap on LTI ratios.  What is clear is that APRA would like to see high LTI lending dialed back and that will have an impact on some borrowers, particularly those purchasing more expensive properties and/or those that have multiple properties.

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