Record price growth driving up ‘risky’ home loans

As property prices continue to rise, the number of borrowers willing to take on risky amounts of debt to secure a property has also increased, according to the banking regulator.

The Australian Prudential Regulation Authority says the share of new lending with high debt-to-income ratios – that is, debt more than six times a borrower’s income – increased to 24.4% in the December quarter.

APRA says the rate of growth in high debt-to-income ratios has slowed, and compared to the previous quarter the increase in the ratio is only slight.

But the percentage is more significant when compared to the previous December quarter, where 17.3% of new loans were in this category and deemed ‘higher risk’.

The big difference between the two December quarters is, according to the Australian Bureau of Statistics, in that 12 month window we experienced our strongest annual growth in property prices since records began in 2003.

The ABS data shows residential property prices increased 23.7% over 2021. Of course, just how much property prices increased varied from city to city, town to town.

In the December quarter of 2021, borrowers in Hobart needed to fork out almost 30% more than they would have a year earlier, on average. Brisbane, Sydney and Canberra also recorded annual price growth of more than 26%.

Borrowing to the limit

A likely reason more borrowers felt they could take on more debt is the cost of borrowing is still at near-record lows, with the Reserve Bank of Australia still yet to increase the official cash rate – although the governor has indicated an increase is ‘plausible’ this year.

Cheap borrowing meant buyers could borrow more and the price of property was pushed up.

Real Estate Buyers Agents Association of Australia President, Cate Bakos, has seen first-hand how that prompted many borrowers to take on additional risk.

“It comes down to your loan-to-value ratio and your maximum borrowing capacity,” Ms Bakos said.

“I’ve certainly seen a lot of people take a more conservative approach and not necessarily stretch themselves to the amount that the bank would be prepared to loan them.

“But the flip-side of that is I’ve seen people increase their capacity and take it to the very edge in an effort to squeeze in a purchase that’s within their realms, within their grasp… they can see if they don’t put that on the table and the market keeps moving they won’t be able to afford ever.”

And this fear of missing out has also lead to an increase in buyers taking on lenders mortgage insurance (LMI), according to data from Digital Finance Analytics.

When borrowing more than 80% of a property’s value lenders will often require a borrower to pay LMI. It protects the lender, not the borrower, if you default on your loan.

More than 300,000 LMI policies were taken out in 2021, 12% more than 2020, according to the data from Digital Finance Analytics.

The increase in policies suggests there were more borrowers who couldn’t manage a 20% deposit on the properties they purchased, so they had to take on this additional debt to get their foot in the door before prices potentially surged again and priced them out of the market altogether.

Signs of improvement

While the percentage of borrowers taking on more than six times their annual income has increased, other indicators that signal risky lending activity have come down, according to PropTrack economist Angus Moore.

“If we’re thinking about risky lending the other aspect that matters is whether loans are actually going into arrears or becoming non-performing and we’ve actually seen that come down in the past year for both investors and owner-occupiers,” Mr Moore said.

“That’s sort of indicative that for most borrowers at current interest rates, they’re able to service their loan and we’re not seeing increases in non-performing mortgages.”

Mr Moore says just because we’re seeing higher debt-to-income ratios it doesn’t necessarily mean we’re going to see more mortgage defaults.

“APRA is very focused on serviceablilty, people’s ability to pay their mortgage and making sure banks are doing a good job of assessing that and when we look at other measures of serviceability in terms of what are your repayments to your income as opposed to your debt to your income,” Mr Moore said.

“Those remain quite low by historical standards.”

This quarter of data also takes into account APRA’s new tighter restrictions on lending, which forced banks to ensure new borrowers could handle their debt if interest rates increased by 3%.

The serviceability buffer came into effect on November 1.

Mr Moore says the most recent data indicates the new buffer hasn’t had much of an impact yet.

Not just borrowing risks

Cate Bakos says the intense competition of the property market has also caused borrowers to take other risks beyond a massive mortgage.

Like other buyer’s agents, Ms Bakos says she saw an increase in buyers buying ‘sight unseen’ or buying quickly after a short inspection of a property.

But Ms Bakos said some risks were even more troubling.

“I saw buyers offering short settlements, certainly not ours, I wouldn’t have let them, but when you’ve got banking delays and COVID issues you really should be thinking twice about making a really short-range offer,” Ms Bakos said.

Ms Bakos said other buyers were also making offers on properties without getting building or pest inspections done, even on older properties which would warrant both.

“A lot of buyers got sick of missing out on property and saw it as a wasted expense or an expense they didn’t want to incur unnecessarily so they were going to auction without these types of reports on hand and I think that’s really dangerous,” Ms Bakos said.