Cost of living pressure on borrowing capacity

In July last year we explained in a weekly finance update some of the challenges facing borrowers when they tried to discharge a loan, particularly when refinancing. Earlier this week, these challenges were brought to the fore with the mortgage industry’s peak body, the Mortgage & Finance Association of Australia’s (MFAA), released a white paper on the matter with 6 recommendations made to ease the discharge pain. These recommendations were –

1. Improving efficiency in the discharge process to encourage more borrowers to switch lenders if it’s the right option for them.
2. In all instances, brokers should be able to act for a customer in the discharge process if the customer provides consent.
3. Implement a simple-to-use and easy-to-find standardised mortgage discharge form.
4. Reduce the time it takes to process a discharge form and complete the switch to another lender.
5. Lenders should offer their best repricing offer upfront, eliminating the need for retention activity once a discharge form is lodged.
6. Automate and digitise the discharge process as much as possible, for example, by accepting electric signatures or online editable forms.

Given the banks don’t like giving up loans, it’s unlikely they’ll be too excited at the prospect of making the process any less complicated than it is.

In this week’s newsletter, we look at the impact cost of living pressure is having on loan approvals.

It wasn’t that long ago, when interest rates were on an upward trajectory, that the subject of borrowing power was a hot topic of conversation.

With every rate increase, the cost to servicing debt went higher, which meant lenders would decrease the amount of money they were prepared to offer borrowers.

To put that into some sort of perspective, in the last two years, the average Australian has seen a 30 per cent drop in their borrowing power in that time frame. So someone who could borrow $750,000 in early 2022 was only able to borrow circa $525,000 in December 2023.

Adding cost of living pressure to the mix

Whilst interest rates increases seem to have ceased, another problem has added fuel to the borrowing capacity fire – increased costs of living.

Cost of living pressures, including rising expenses for essentials like groceries, utilities, and healthcare, reduce the disposable income available for mortgage repayments. When lenders assess mortgage applications, they carefully consider an applicant’s ability to meet repayments while managing their living expenses.

As the cost of living has increased, lenders have rightly perceived that borrowers have less capacity to afford mortgage repayments, which limits the amount they can borrow.

The combined impact of cost of living pressure and high-interest rates significantly affects an individual’s ability to secure a mortgage.

How to lenders assess household expenditure?

The Household Expenditure Measure (HEM) is a benchmark used by lenders to estimate a borrower’s living expenses when assessing a mortgage application.

It’s based on statistical data regarding typical household spending patterns. Lenders use the HEM to calculate a borrower’s ability to repay a loan, factoring it into their serviceability assessment alongside income and other expenses.

While it provides a standardised approach to assessing living expenses, some critics argue that it may underestimate individual spending needs, leading to potential inaccuracies in assessing borrower affordability.

Variable

The rates below are based on a $500,000 loan, with the borrower making principle and interest payments with a loan term of 30 years. The rates quoted may vary depending on the borrowers LVR.

1 Year Fixed

The rates below are based on a $500,000 loan, with the borrower making principle and interest payments with a loan term of 30 years. The rates quoted may vary depending on the borrowers LVR. At the end of the three year fixed period, the borrowers interest rate will revert to a standard variable rate for the life of the loan.