NAB, Westpac, and CBA have lowered serviceability tests for refinance home loans: what does that mean?

Over the last two months, NAB, Westpac, and Commonwealth Bank have all announced they will lower the home loan ‘stress test’ for select refinancers from the standard 3% to 1%. For eligible borrowers, this means instead of having to qualify for mortgage rates as high as 9%, they may only have to pass 7%. 

But the move has raised eyebrows among Australian regulators, who justifiably argue that the 3% serviceability buffer exists for a reason. 

So what does this change mean for borrowers refinancing with the Big Four? And is this a bad move for the banks? Let’s dive in.

Usually, when customers apply for home loans, the lender will assess their ability to pay interest rates 3% above and below the rate they’re applying for. 

For example, if you apply for a 5% interest rate, the lender will test your ability to make repayments (“service your loan”) at 8%. The Australian Prudential Regulation Authority (APRA) requires this 3% buffer to prevent high-risk lending to borrowers who can’t afford rises and falls in their variable interest rate home loans.

However, interest rates have easily jumped more than 3% in the last year, thanks primarily to lenders passing along rate hikes from the Reserve Bank of Australia (RBA). Many borrowers have scrambled to refinance their mortgages and escape ballooning monthly repayments, but some have run into immense trouble with the 3% serviceability test. 

Many of the most recent borrowers bought during the Australian property boom when home loan interest rates were at an attractive low. In July 2020, the average variable rate for owner-occupied home loans sat at just 3.40% in the Mozo database. Now, the average rate for the same loan is 6.57% – 317 basis points higher. 

So while buyers back then would only have to qualify for interest rates at 6%, now they have to qualify for rates at 9% or above, and for those already struggling, that’s just not attainable. Unable to refinance, they may find themselves home loan hostages, or worse, mortgage prisoners.

For eligible refinancers applying to home loans with Westpac, CBA, and NAB, that 3% stress test has been brought down to 1%. So no, a refinancer applying for a loan of 6% only has to qualify for rates up to 7%, which may be more realistic than 9%. (So far, no changes have been made at ANZ).

Customers will still need to demonstrate a good home loan credit score and clean debt history, as well as any minimum LVR or monthly repayment requirements the individual Big Bank may have. However, the changes could make it easier for borrowers to refinance and escape unbearably high interest rates.

These latest changes from the Big Four have drawn the eyes of APRA, the original creator of the 3% serviceability test. The idea of the test was to stop lenders from taking advantage of borrowers when they first take out a home loan. If you buy it, you must be able to afford it. 

In a letter to the big banks, APRA chairman John Lonsdale urged that the 3% stress test still applies, save for specific “exceptions” in “limited” situations.

“The serviceability buffer provides a contingency for rises in interest rates over the life of the loan, as well as for any unforeseen changes in a borrower’s income or expenses,” Lonsdale explains.

“With the potential for interest rates to rise further, inflation still high, and the possibility of weaker labour market outcomes, the buffer is an important risk mitigant.”

However, Lonsdale admits so long as the banks remain prudent and honour the spirit of the serviceability buffer, as well as actively report which loans they approve under the new 1%, it can help reduce the risk to both the bank and their borrowers. 

In the meantime, it’s still vital for refinancers to clean up their finances before switching home loans, namely by:

• Monitoring their spending and saving.
• Clearing extra debt.
• Checking their application for home loan red flags.

Compare refinance home loans in the table below.