Home loan buffers on the increase

On the back of RBA's warning, lenders are increasing the "buffers" used to assess borrowers ability to repay their mortgage, amongst concern that they may not be able to meet repayments when Australia's record low interest rates begin to rise again.

More stringent loan criteria have been put in place in the last few months after the Reserve Bank of Australia cut the cash rate to just 2.5%.  Financial regulators have been putting pressure on banks not to lower their lending standards and to put in place tougher credit restrictions to ward off a house price bubble.

"Interest rates are at historic lows and at some point... they are going to start going up and at that point you want to be confident that those loans are going to be serviceable at higher interest rates," Australian Bankers' Association chief executive Steven Münchenberg said.

Lending institutions use an interest rate "buffer" calculated above their current home loans rates to test whether a prospective borrower will be able to afford to repay the loan in the long term. Although lenders are reluctant to disclose the exact criteria they use to assess loan applications,  the AFR has estimates a 2% buffer will be used after the RBAs latest rate cuts.

The rise to 2% is s significant change on last year when buffers between 1.25% and 1.5% were typical across the board.

Stricter lending criteria will mean that if a bank is offering a mortgage interest rate of 5.5%, the loan will not be approved unless a borrower is able to [rove they can service a loan at 7.5%.

Some banks are also introducing interest rate "floors" in their assessment criteria suggesting that they will continue to assess applications against a higher rate, even if the RBA cuts rates again.