What is the APRA serviceability buffer?

Australia’s borrowers have a nervous week ahead as ABS data this week revealed that June quarter inflation quickened but largely as the Reserve Bank had expected, giving the central bank confidence it won’t need to hike interest rates again to curb price rises.

The consumer price index rose to 3.8% in the June quarter from a year earlier. That result compared with economists’ forecast of 3.8% and the March quarter rate of 3.6%. So whilst the number is up, it was as expected so most pundits are betting on rates staying steady.

That won’t stop the RBA continuing to threaten imminent increases when their commentary get’s released next Tuesday afternoon.

In this week’s newsletter, we take a dive into the Australian Prudential Regulation Authority (APRA) mortgage serviceability buffer.

The APRA mortgage serviceability buffer is a regulatory measure that requires lenders to assess a borrower’s ability to repay a loan at an interest rate 3 percentage points higher than the actual loan rate.

This buffer ensures borrowers can afford repayments even if interest rates rise, thereby safeguarding against financial instability.

Implemented by the Australian Prudential Regulation Authority (APRA), the buffer aims to maintain the financial soundness of banks and protect the broader economy from excessive credit risk, particularly in periods of economic uncertainty or rising interest rates.

Does the buffer ever change?

Over the past 20 years, the buffer has seen adjustments to address evolving economic conditions and financial risks. Initially, the buffer was less standardised, with banks using varying methods to assess borrower capacity.

In December 2014, APRA introduced a minimum buffer of 2 percentage points above the loan rate, formalising the practice.

In July 2019, APRA increased the buffer to a flat 2.5 percentage points.

However, in October 2021, in response to rising housing market risks and increasing household debt, APRA raised the buffer further to 3 percentage points. This adjustment was aimed at ensuring borrowers could withstand potential interest rate hikes, which of course did materialise with a dramatic increase in interest rates in recent years.

Does the buffer effect borrowing capacity?

Yes, the buffer affects borrowing capacity. By requiring lenders to assess borrowers’ ability to repay loans at an interest rate 3 percentage points higher than the actual loan rate, the buffer effectively reduces the amount borrowers can qualify for.

If the buffer comes down to it’s historical ‘normal level’ of 2% – 2.5% then a persons borrowing capacity will increase.

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.