A buffer rate is one way lenders assess how much you can afford to borrow. More lenient rules around the buffer rate may mean you can now afford to buy a home.
Australia’s banking regulator has lowered the lenders’ borrowing ‘buffer’
Lenders use many measures to determine if you are able to afford a loan. One of these is to add a ‘buffer’ to the current interest rate and assess whether you are able to repay the loan at this higher rate.
For the last few years Australia’s banking regulator, APRA, has required lenders to use a minimum 7 per cent interest rate as the buffer rate. This has been the case even though the rates lenders were offering were lower. With interest rates at historic lows, this buffer protected borrowers from repayment pain if rates ever went up.
However, rates haven’t gone up. After remaining unchanged for a long time, the Reserve Bank’s official rates have dropped twice in the last two months. They have reduced from 1.5 per cent to 1 per cent. So the gap between the rates lenders are offering and the buffer rate has become so high that it no longer reflects the loans available. As a result, APRA has now relaxed the rules around the buffer rate.
Lenders can now set their own buffer rate
Lenders can now review and set their own minimum interest rate floor. This is provided it’s a buffer of at least 2.5 per cent more than the loan’s interest rate. With home loans available at well below 4 per cent pa, lenders can now assess your loan at around mid-5 percent pa.
For APRA, it’s all about flexibility. Lenders can set their own serviceability standards for their borrowers. This can improve access to loans and provide more competitive products, while still maintaining a good level of responsible lending practices. For borrowers like you, it’s all about affordability and borrowing power when buying a new home.
A lower buffer is better for borrowers
In simple terms, this change could mean that more people can now get a home loan. People’s borrowing capacity will increase as the amount of interest they need to cover each month decreases. For many people looking to get a new home loan, this could mean the difference between getting approved or not. If you’re already a homeowner, a boost to the housing market may help protect the value of your home.
You may be able to borrow more as a result
The APRA change is essentially about improving serviceability – your ability to make the repayments on a regular basis. On top of your deposit, a lender will look at your income, living expenses and existing debt. They will then calculate whether you’ll have enough money left over to afford the repayments. To work this out they come up with a score called the net income surplus (NIS). Obviously, this needs to be positive, i.e. the money you have left over to pay the loan is more than the repayments.
That’s why APRA still need lenders to include a buffer. If rates go up, your repayments go up and you may no longer have enough money left over to service the loan. The new 2.5 per cent buffer still protects you from this.
As well as serviceability, there are other factors lenders take into consideration. Things like:
Loan to Value Ratio (LVR). This is how much deposit you have compared to what you need to buy the home. If you have a $60,000 deposit and the home is valued at $300,000, your LVR is 80 per cent. Banks generally like an LVR of 80 per cent or lower, but it can be as high as 95 per cent.
Debt to Income Ratio (DTI). Lenders look at how much you earn to help work out how much you can borrow. Your DTI ratio is your total debts divided by your combined income (before tax). A loan of four or five times your income is a good ball park figure.
As you can see, the way a bank assesses your serviceability to approve you for a loan is a lot more complex than simply plugging in your income and applying their interest rate. And working out factors like your NIS, LVR and DTI can be tricky and time consuming.
It’s so important you know exactly where you stand in the eyes of a lender before you apply by getting an accurate financial snapshot of your current situation. You don’t want to make the mistake of using an official application process to establish your borrowing power.
That’s why we’re here to help. We’ll sit down with you and go through all the details a lender requires, to not only help you navigate the process and make sure you look good to the lenders, but also to ensure you find a loan that’s right for you.
Please get in touch with the mortgage brokers at Milestone Lending to organise a chat. We’re more than happy to do it at a time and place that suits you.