What is the APRA buffer rate?
According to APRA's rules, banks must have specific basic requirements when evaluating if a borrower can repay a home loan. This includes a minimum serviceability buffer of 3%, which is added on top of the mortgage interest rate.
Essentially APRA instructs banks to evaluate both new and refinanced loans by calculating an interest rate that is 3 percentage points above their present rate. For example if a bank's standard variable home loan rate for new customers stands at 6.00 percent, APRA would review whether prospective borrowers can still manage their loan payments at a rate of 9.00 percent.
What is the reason for the APRA buffer rate?
The purpose of this buffer is to safeguard borrowers from facing financial difficulties in the event of future interest rate hikes or unforeseen changes in their financial circumstances due to income or expenses.
There may be rises in interest rates over the life of the loan for example during 2023 the RBA (Reserve Bank of Australia) increased interest rates by 1.25% per annum. Which meant over the course of 2023 the RBA decided to increase the cash rate by 0.25% per annum in February, March, May, June and November.
Given the prospect of potential future increases in interest rates due to persistent high inflation, and the chance of less favorable labor market conditions, the buffer serves as a crucial measure to reduce risks.
Lender Exceptions to APRA Buffer
Recently some banks have modified their practices for handling special cases to assist borrowers encountering difficulties in refinancing with a different lender. A "policy exception" may happen when a bank grants approval for a loan that doesn't meet the usual loan criteria, such as the serviceability buffer. Within APRA's prudential framework, banks have the flexibility to enact policy exceptions, provided they manage them wisely and restrict their use. This strategy allows banks to consider supplementary avenues of repayment capability beyond those assessed in the standard serviceability test. Responsible banks should provide valid reasons and transparent justifications for loans approved outside the established policy to APRA.
Refinancing a Home Loan
Borrowers may be looking to refinance if they are coming out of a low fixed rate of 2% with no increase in income level. Despite recent years of home loan borrowers facing increasing challenges in refinancing their mortgages with different lenders at higher interest rates the 3% serviceability buffer has remained. A recent 2023 report has found the past 12 rate rises have added $14,688 per year to the cost of servicing a mortgage in Australia. However The Council of Financial Regulators (The Reserve Bank, Treasury, Australian Securities and Investments Commission, and the Australian Prudential Regulation Authority) decided in 2023 to continue to enforce the 3% serviceability buffer for all home loan applications. In light of rising rates and the increase in the cost of living, more borrowers are looking to refinance but can often miss out on getting a better interest rate due to a lack of knowledge.
It is strongly recommended that you take the time to research well, compare all options and seek information from different lenders to make sure you choose a competitive rate when you originally purchase a property and enter into a mortgage contract.