The elephant in the room for residential property is the ongoing pressure on banks' net interest margins. While the recent rise in funding costs has been well documented, this dynamic is persisting.
Lenders previously had a bit of a free kick on some investor and Interest Only (IO) mortgages, with the introduction of an interest rate differential between product types. But as more IO loans are being switched to principal repayment there is further pressure on margins.
Westpac’s 3Q18 release showed a portion of its tighter margins being attributable to a decline in its unusually large stock of IO loans. And this pressure valve will need to be released through higher variable mortgage rates.
A challenge the major lenders will face is a potential loss of market share, with some non-banks already having stepped into the breach.
Labor’s proposed changes looming large
The other looming elephant in the room is the ALP’s proposed changes to negative gearing and the capital gains tax ‘discount’. This is especially pertinent given the implosion of support at the polls for the Coalition following the latest leadership spill debacle.
A special market report we recently co-authored with RiskWise Property Research concluded that if the changes are implemented as proposed, we can expect to see additional dwelling price declines across the board. This is a critical issue both for incumbent property investors and their portfolios and for prospective investment decisions. We recommend preparing well in advance accordingly.
To what extent are lending standards crimping borrowing?
Tighter lending standards have quite rightly been a key focal point. There have been some wild estimates of reduced borrowing capacity from various sources, but these don’t seem to be supported by the reality. Indeed, in some of the more extreme instances, it’s unclear how these conclusions have been reached at all (perhaps through exaggerated expense allowances?).
To this end, we’ve done some research via mortgage broker liaison, and it looks as though where applicable the reduced borrowing capacity has been in the region of 5 to 10 percent, and perhaps a bit more for some investors.
Of course, individual experiences may differ significantly. Certainly, the monthly housing finance data has to date shown very little impact on the average loan size for owner-occupiers.
It’s probably fair to say that more mortgage applications have been rejected, so there is likely to be a bit of a compositional change in play. So, to some extent this may reflect a greater focus on borrowers of sound credit quality.
Portfolio investors and those with multiple existing interest-only (IO) loans may be impacted more significantly. And as we flagged here 12 months ago, the IO reset will continue to be a dynamic worth watching closely.