Home Insights Fresh financial hit for first-home buyers with upcoming changes from APRA

Fresh financial hit for first-home buyers with upcoming changes from APRA

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APRA, a banking regulator, is proposing to increase the “risk weight” of high-value loan to valuation (LVR) loans from January 1, 2023.

This change can make it costly to take out a mortgage with a high loan-to-valuation (LVR) ratio.

First home buyers are usually more affected by this than other borrowers due to their high LVR.

APRA aims to change the way banks assess mortgage risk

APRA has proposed to change the “risk weight” of mortgages.[1] APRA Proposed rules For consultation at the end of last year, with the aim of finalizing this year’s rules, before coming into force on January 1, 2023.

Risk weight is one of the pillars of modern bank regulation.

The idea is that bank assets (for example, mortgages and loans to businesses) are counted differently based on the degree of risk. The higher the risk of an asset, the higher the risk weight and the more equity the bank needs to have as a buffer.

Equity is one of two ways banks can raise their own money (think of it as stocks or retained earnings). Another way is to borrow money. Deposits at banks are debts. So are bonds and short-term bills.[2]

The main feature of equity is that you don’t have to repay it. buffer Against the loss.

This buffer is important.

If the loan loss is too large and the equity buffer to absorb the loss is too small, depositors and bondholders may be concerned about the bank’s ability to repay the money. This can lead to bank runs and financial instability. This happens many times in history and usually leads to a recession.[3]

This is why modern banking regulations (and APRAs that oversee banks) exist. This is to avoid the bank crisis and the resulting recession.

With this change, interest rates will be more sensitive to mortgage LVRs.

As the graph below shows, the new rules make risk weights more sensitive to mortgage LVRs at the time of origination.[4]

As a result, a mortgage to a home with an 80-100% LVR will attract a higher risk weight than it is today, even if the borrower has a lender’s mortgage insurance.

The good news for some homeowners is Low LVR mortgages attract lower risk weights. Under current rules, all loans with an LVR of less than 80% are treated the same. Investor loans, or interest-only loans, also attract higher risk weights in almost all LVRs.

This change is designed to reflect the fact that high LVR mortgages are at high risk.

APRA data Shows that borrowers with high LVR mortgages at the time of origination are more likely to be overdue.[5] Also, because mortgages are close to the value of a home in the first place, banks are more likely to lose money if they are forced to seize a high LVR mortgage.

This change could make high LVR mortgages more expensive

This change means that banks need to have a larger equity buffer for higher LVR mortgages than they currently have.

Equity is a costly way for banks to raise their own money. In short, this proposed change will increase the cost of high LVR mortgages for banks.[6]

Banks will probably pass on that increased cost to the borrower.

This means that high LVR borrowers will probably pay a relatively higher rate than today. In contrast, low LVR borrowers may be able to get cheaper rates.[7],[8]

That wasn’t the case in the past. Banks charge a little more for mortgages with LVRs above 80% (about 7 basis points in the last few years). Its premiums have recently expanded to nearly 20 basis points and may foresee these changes proposed by APRA.

First homebuyers are most affected by the change

Higher LVR mortgage rates hurt first home buyers.

The first home buyer many You are more likely to take a high LVR mortgage than any other borrower.From recent charts RBA breaking news articleAlmost Three-quarters of The LVR for the first homebuyer’s mortgage in January 2022 was over 80%. That was just one-third of other home mortgages.

Saving deposits for many first home buyers the Restrictions on owning a home, especially as home prices soared. As a result, low deposit / high LVR mortgages are more common for these buyers.

By making high LVR mortgages more expensive, APRA’s proposed changes could make it even more important to have that deposit.

[1] A complex factor is that these risk weights are for a “standardized approach”. Not all banks use a standardized approach. Instead, banks can choose to use “internal rating-based” risk weights. In this case, the bank chooses its own risk weights to apply to different assets based on its own risk modeling. Nonetheless, these are monitored by APRA, so standard risk weights provide guidance.

[2] Breaking a bank’s balance sheet into debt-to-capital is oversimplified and there are a range of options. As an example, a bank can issue securities (called contingent convertible bonds or CoCos), such as shares that are counted as shares for regulatory purposes. Like bonds, they pay a fixed interest rate and repay the principal at maturity, but they need to repay when the ratio of equity to the bank’s liabilities falls below a certain (defined) threshold. There is none.

[3] This happens because the depositor stops lending to the bank. In other words, banks cannot lend to businesses or households, ruining the economy as a whole (which relies heavily on the credit of banks for their daily work).

[4] These risk weights apply to all “standard qualifying mortgages”. This applies to most homeowner mortgages other than unsecured or low-value loans. This means that the bank has the first registered mortgage and has documented, evaluated and validated the borrower’s solvency.

[5] To be clear: it doesn’t necessarily mean a higher LVR Cause By default, it’s just relevant. The types of borrowers who take advantage of our high LVR are different from those who take out high LVR mortgages, perhaps in an unobservable way.

[6] Below this statement is considerable complexity. The cost of debt funds is the interest paid by the bank. This is pretty low. For example, a 6-month bank-approved invoice (a type of short-term debt issued by a bank) is 0.25%And long-term bank bonds Less than 2%..Deposits are even cheaper for banks – online savings accounts are now Pay 0.05%.. Equity “cost” is the expected return that an investor needs to invest in and hold a bank’s equity. Although not directly observable, Australian estimates are usually Range of 10-15% (Substantially higher than the cost of debt). The wrinkle is that in economic theory this distinction is meaningless. The more equity you issue, the safer your debt will be and the lower your debt costs will be. Theoretically, this means that the cost of financing is invariant to the choice of capital structure (Modigliani and Mirror 1958). In reality, this is not the behavior of banks (or the entire sector of corporate finance), so let’s ignore that argument for our purposes.

[7] This is relatively likely that the RBA will raise interest rates before these changes take effect, which will raise mortgage rates on all mortgages.

[8] This wasn’t really the case in the past. Mortgages with an LVR of more than 80% for owning a home had a premium of only 0.05% compared to a mortgage with an LVR of less than 80%. This has changed a bit lately and may foresee what comes with these future changes.

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