How interest rates import your borrowing capacity

Higher interest rates make it harder for borrowers to qualify for larger loans or even loans of any size. That’s because for every increase of 0.50 percentage points in interest rates, the average person’s borrowing capacity falls by about 5%, according to PropTrack senior economist Paul Ryan.

Since 2022, the Reserve Bank of Australia (RBA) has increased official interest rates by 4.25 percentage points, thereby reducing the average person’s borrowing capacity by about 40%.

If and when the RBA starts cutting rates, borrowing capacities will rise. In the meantime, the banking regulator, APRA, could achieve the same outcome by reducing a thing called the mortgage serviceability buffer.

Currently, to protect borrowers and the banking system, lenders need to add a buffer of at least 3 percentage points when assessing someone’s ability to repay a home loan – so if, hypothetically, you applied for a loan with an interest rate of 6.20%, lenders would assess whether you’d be able to make your mortgage repayments if the rate rose to at least 9.20%.

If APRA reduced this buffer requirement to say 2.5 percentage points or 2 percentage points, the assessment rate on the hypothetical loan mentioned above would fall, thereby increasing your borrowing power.

However, APRA recently ruled that it would keep the buffer at 3 percentage points. “In reaching the decision to keep the settings steady, APRA took account of high household indebtedness and a pick-up in credit growth, persistent cost-of-living pressures, a weakening jobs market and heightened geopolitical risks,” the regulator said.