Buffer for borrowers in home loan stress tests

A suite of interest rates, that banks keep under wraps, may be what ensures homeowners don’t have to sell as home loans get more expensive.

The rates, sometimes called stress test rates, are used by banks when you first apply for a loan, to work out whether you can afford it.

But they aren’t applied at the rate you might see on a sign in the bank window. Sometimes they are twice that. They’re designed so that increases in home loan rates, as we are starting to see now, do not leave large numbers of people unable to pay their mortgages.

Brokers say current stress test rates range from 3.49 per cent to 5.8 per cent and 6.5 per cent, though they have started to rise slightly in recent weeks, following increases in advertised rates.

But while 3.49 per cent might look like an easy target for applications, brokers said the banks using lower rates usually also used a higher expenses calculation and required borrowers to have more money set aside for bills than the others did. The bank assumed some of those expenses would be cut if repayments rose, allowing the borrower to keep servicing the loan.

So while you might balk at the idea of your home loan payments becoming more expensive, the bank has already checked that you can cope with it – either with slack that is already in your budget, or with spending cuts you can make.

Broker Glen McLeod said many homeowners had opted to keep their repayments the same when interest rates fell, which meant they got ahead on their mortgages and did not face a jump in repayments now.

It was natural to worry about interest rates rising, he said. ‘‘But they don’t realise they’ve already been stress-tested at a much higher level.’’

Banks took responsible lending rules seriously, he said. ‘‘Going back years and years, they wouldn’t have asked for applications to include expenses like insurance but some now make us put those in and do the stress test with those on top. They’ve taken a prudent approach.’’

How much might interest rates rise?

Many economists and analysts predict the official cash rate will rise to 1 per cent by February and will hit 1.5 per cent to 2 per cent in the next year or so.

According to Reserve Bank data, the last time the OCR was at 1.5 per cent, in May and June 2019, the average new one-year rate was 4.6 per cent, compared with 3.7 per cent last month.

A $600,000 loan with a 4.6 per cent interest rate would cost $1554 a fortnight over 25 years, compared with $1416 at 3.7 per cent.

CoreLogic estimated that a buyer with a $800,000 mortgage on a 30-year term whose interest rate increased from 2.59 per cent to 6 per cent (which it noted was not in current forecasts) would have to repay an extra $1597 a month.

‘‘Even a new borrower with a lesser mortgage, say $500,000, will need to find another $246 to

$388 a month ($2952 to $4656 a year) in repayments if rates move up to 3.5 per cent or

4 per cent.’’

McLeod picked a maximum 5 per cent. A home loan ‘‘war’’ in Britain has led banks there to offer five-year loans at less than 1 per cent interest.

John Bolton, the founder of mortgage broking firm Squirrel, expected to see heat come out of interest rate increases before long. He said it was common to see rates spike when people started to worry. The demand for fixes outpaced the rate at which banks were able to secure funding.

He said, with about 80 per cent of the country’s home loans on fixed rates, and most on short terms, there was a ‘‘massive amount’’ of maturing fixed rates.

‘‘So you can imagine you get all these people on one-year fixed rates freaking out about rates, trying to fix for three years, [then] rates spike up really fast,’’ Bolton said.

‘‘My message to borrowers is just not to panic about it. The massive increase in rates will settle down. The spike in wholesale interest rates is largely driven by [the] massive amount of consumers rushing out to fix . . . People will settle down, the panic disappears and rates will normalise.’’