and how will it affect your borrowing capacity?

It is harder to borrow money from the banks than it was a few years ago. Tighter lending restrictions has reduced many people’s borrowing capacity, while others may not be able to borrow at all.

Recently, it has been reported that for the first time in years there is a strong chance that the Reserve Bank of Australia will cut the official cash rate. Historically, this meant that the interest rate you pay on your home loan would go down and that new loans should also be cheaper.

This should make borrowing money from the banks easier, right? Unfortunately, no. When a bank calculates your ability to repay a loan it does so at an inflated interest rate, usually at 7.25% interest. This 7.25% figure is called the assessment rate or buffer rate.

For example, Bank ZYZ may offer a customer a $450,000 mortgage with an interest rate of 3.80%. Principal and Interest repayments over 30 years for this loan will be $2,097 per month. However before approving then loan to the customer, the bank will apply the assessment rate of 7.25% to the $450,000 loan which works out to $3,070 per month. A customer must be able to afford these repayments before the loan is approved.

So why does this matter? The current drop in property prices around the country, has a lot to do with the reduction in consumer borrowing capacity. If people can’t borrow money, they can’t buy property. A number of economists are now commenting that the quickest way to stop falling house prices is to make borrowing easier by lowering the buffer rate to under 7%.

Will this happen? My prediction is that it will soon enough.

Stay tuned.

Michael