The Banking Royal Commission is working to stop our biggest banks’ irresponsible lending behaviour. Will their actions make the property market downturn even worse?
The Financial Services Royal Commission uncovered some irresponsible lending practices in our banks. Namely, young adults can enter into a joint loan secured against an elder’s home. Since there’s a much higher chance that the young person might not be able to service the loan, the risk of default is quite high.
To put a stop to this, as well as other forms of misconduct, the commission is scrutinising our biggest banks’ lending behaviour. Many people fear that this can make it harder to secure loans. And fewer buyers would lower property prices even further.
Though there are valid reasons why this could happen, some experts think this will have no impact on the property market. Let’s take a closer look at the likely effects of these changes.
How Might the Changes Affect Borrowers?
If the federal government green lights the Banking Royal Commission, borrowers and mortgage brokers will have the most to lose. Currently, mortgage brokers get an upfront commission from the lending bank when their client gets approved for and takes out a loan. In addition, the bank pays a trail commission, as well as an ongoing fee.
The Banking Royal Commission proposes for the borrower to pay the upfront fee. In essence, the borrower would pay the brokerage fee, which becomes a part of the mortgage. The idea is to eliminate conflict of interest, as it is likely for the broker to work in the interest of the party who pays them.
However, this will discourage borrowers from going through a broker. Since this could add about $2,000-$2,500 to the mortgage, they’ll want to go straight to the bank. This is very likely to push many small and medium brokers out of the market. Those who stick around will have to adjust their fee structure to survive.
This might create a ripple effect that puts borrowers is a very unfavourable position. First of all, they’ll have to go through the whole process on their own. They’ll have to deal with a lot more paperwork and departments to get a loan.
Worse yet, it might become much harder for borrowers to find a good deal. Brokers always give borrowers multiple options from various lenders. By removing them from the picture, banks might limit the selection of loan products and increase their monopoly. It’s almost certain that they’ll take advantage of this to dictate loan terms that suit their needs rather than the borrowers’.
Overall, it’s a major change that might create problems in the mortgage sector. So, will this push property prices down even further? Let’s take a look at what the experts have to say.
Arguments in Favour of Further Price Drops
Professor of Finance Harry Scheule (University of Technology) believes that the commission might have a big impact on property prices. He states that this will make banks much more wary of the risk of default when giving out loans. This will rebalance loan sizes compared to borrowers’ earnings and serviceability.
What this means is that they’ll reject more loan applications. Going forward, they might approve fewer and fewer loans. Consequently, people would have much less money to use for bidding in real estate. In the long run, this could make houses more affordable. Still, an important thing to consider is future wage growth. If this doesn’t keep up with the times, Scheule is certain that housing prices will drop even further.
Brendan Coates, a fellow at the Grattan Institute, agrees. He states that prices will inevitably drop, at least in the short term. However, Coates believes that the effect will be quite modest.
This is because our banks have already tightened their criteria over the past few years. The APRA saw to it with a few measures. The number of approved loans went down drastically after 2014, especially those that exceed 80% of the purchase price. Further restrictions may make it harder to get a loan, but Coates thinks that the change will be relatively insignificant.
On the other hand, Paul Dales of Capital Economics believes that the impact of these changes will be huge. He explains:
‘At the moment the trajectory is a bit worrying cause the house prices seem to be declining at a faster rate and, in our view at Capital Economics, this will eventually prove to be the largest downturn in Australia’s modern history’
Dales believes that this is inevitable if higher interest rates follow these changes. What’s more, he states that the effect will be long-lasting. This is because it will happen gradually happen without any visible signs at first. In time, it will become more pronounced.
UBS’ research also bears this out. It shows that tighter lending standards will reduce lenders’ borrowing capacity by 30-40%. As a result, property prices might drop by another 5% by the end of 2019.
Arguments Against Further Price Drops
There are also experts who believe that there’s no reason for further depression in price.
Lecturer in Economics and Finance Maria Yanotti (Tasmanian School of Business & Economics) thinks that the changes won’t affect prices in the long run. She points to price drivers such as population growth, construction costs, and land availability. And financing access and cost would play a minor role compared to these factors.
Yanotti believes that the changes are likely to cause banks to raise interest rates. This is because the changes will make it more costly for banks to process loans. While this will discourage those who want to own a home, it will increase the demand for rental property at the same time. From the perspective of businesses and investors, the higher interest rates wouldn’t affect the demand.
Rachel Ong, Professor of Economics at Curtin University, doesn’t think that the commission will bring many changes. In her opinion, the current state of the property market is the result of decades of overinvestment. Tightening lending standards wouldn’t be disruptive enough to drive prices down.
Negative gearing, the FHOG, and tax relief have systematically changed our property market. When you add the all-time low RBA cash rates and financial deregulation to this, Ong’s argument makes a lot of sense. Even if banks start o charge higher interest rates, it won’t be significant enough to push property prices down.
Sam White of Loan Market Group agrees. He comments:
‘There’s a lot of anxiety at the moment with talk of price declines and the royal commission has made people sit on their hands. Some banks have gone a lot further than others in terms of tightening and I think those banks will get a bit looser, and others will become stricter’.
In his opinion, the changes might simplify the loan approval process. As a result, people would have more confidence in their ability to get a loan and invest.
Protecting Yourself from Uncertainty
What will actually happen if our government approves the commission is still unknown. As you can see, both sides make compelling arguments. This kind of uncertainty can make many investors anxious. The changes might affect their ability to sell their current assets for profits and invest in new ones.
However, this doesn’t mean you should just sit and wait to see what happens. Rather, you need to find a way to minimise your exposure to these changes. So that no matter what happens, you’ll be able to ride it out without incurring losses.
Wealth for Life can help you to do just that. We are all property investors and many of us have successfully navigated similar situations in the past.
Contact us to see what you can do about the expected changes.