One of the more important changes announced this week was the decision to lift the limitations on interest only loans.
Regulator the Australian Prudential Regulation Authority (APRA) removed the 30% limit on interest only loans which it introduced in March 2017.
However, anyone expecting a “happy days are here again’’ quick recovery for the big property markets of Melbourne and Sydney is dreaming.
Rule relaxation will take time
While the initial limitation on interest only loans took a while to work its way through the system, this relaxation of the rules will take much longer to have any effect.
For a start, the entire banking system has now tightened up property lending of all types since the interest only speed limit was first introduced.
There won’t be any rush of new investment property borrowers itching to grab a large interest only loan and even if there were, the big banks won’t be giving the money to them.
Reasons why the banks are being conservative
The reasons for that more conservative lending profile are fairly clear, being:
– The Royal Commission has already forced a radical rethink of prudential lending requirements, meaning the banks will now ask many more questions about income and spending before granting a loan, which is likely to be smaller and require a bigger deposit.
– Property prices are still falling so there are fewer buyers around. Those that are in the market are being particularly choosy.
– Interest only loans are predominantly used by investors who want to maximise their tax deduction and their ability to retain cash flow and buy multiple properties, although some banks were previously selling interest only loans to owner occupiers.
– Interest only loans only make sense if prices and rents are rising – otherwise you are losing money.
– Banks have been raising interest rates on interest only loans for some time, crimping the cash flow advantage for investors compared to having a principal and interest loan.
Gloom has been overcooked
The pessimists have been overcooking their gloominess about Australia’s real estate market.
So far, the property market correction has been orderly and sensible – prices are down but banks are not repossessing properties in massive numbers and loan defaults in general remain low.
That is not to say there isn’t pain being felt as a whole new generation learn that property prices can and do go down – particularly if you are an investor or own multiple properties.
All loans are made to be repaid over time and Australians on the whole will go without food rather than default on their home loans.
Investors, on the other hand, are liable to sell and lick their wounds once the pressure gets too great.
Balanced market at hand
What we are now seeing is a more balanced market in which buyers have regained some power and sellers are having to meet the new reality of lower prices.
All, of which, is fantastic news for those home buyers who have felt locked out of the market for so long and are now actively looking for properties at the cheaper end of the market, which has been particularly robust.
If this downturn follows the pattern of previous downturns, prices will keep falling or go sideways for a couple more years before some confidence slowly comes back into the market.
Bill Shorten is the secret sauce
The one caveat on all of this, of course, is that we are coming up for a Federal Election next year with Bill Shorten now odds on to be our next Prime Minister.
And Mr Shorten carries with him a couple of controversial policies with the ability to further impact the property market – a removal of negative gearing for all but new homes (with existing arrangements grandfathered) and a halving of the 50% capital gains tax discount on sale profits.
It remains to be seen whether Mr Shorten keeps these promises and is able to legislate them through the Senate but they have the potential to make this property correction longer and nastier than those before it.
Interestingly, these policies should also be causing a rush of new investment property buyers at the moment, due to the fact that these investors would enjoy more flexibility in the type of property they can buy (old or new) and face lower capital gains tax bills down the track when they sell.
It is a complicated picture with a lot of political moving parts but the removal of the speed limit on interest only loans is one small ingredient that brings us closer to an eventual recovery in the Australian real estate market.