As the Reserve Bank meets to consider whether to follow in America’s footsteps and cut interest rates, housing affordability is again centre stage of the political debate.

Money markets are betting there’s less than a 20 per cent chance the Reserve Bank will start cutting rates this year, and most economists agree that a rate cut is unlikely until February 2025.

As the threat of higher interest rates lingers for longer, it’s not just those who already have home loans feeling the pain — it’s also making it harder for first-time buyers to borrow enough money to get into the property market.

“There are so many hurdles for us [first home buyers] already to jump through,” said 22-year old Cassie McLaren, who will turn to the bank of mum and dad to supplement what a bank will lend her to try to buy a property in Melbourne.

A parliamentary inquiry is currently looking into the hurdles to home ownership.

Liberal Senator Andrew Bragg is heading that inquiry and hints at some big policy changes it is considering, and that the Coalition could take to the next federal election.

“One of the reasons (housing is getting out of reach) is that the lending laws are very rigid and blunt, and they give no quarter to prospective first-home buyers.”

Lending restrictions reduce risk but have they gone too far?

To avoid masses of Australians defaulting on their mortgages, there’s several restrictions on how much banks can loan, and how much capital they need to hold in reserve to balance against the risk of those loans not being paid back in full.

These restrictions became more stringent after the global financial crisis (GFC), as Australia’s financial market and banking regulators worked to reduce “risk” in the system.

Senator Bragg says the inquiry is considering whether there’s now a need to adjust the restrictions.

It’s also examining whether the nation’s banking watchdog needs a wider mandate that would force it to consider the plight of borrowers when setting guidelines for lenders.

“At the end of the day, we’re not trying to eliminate all risk,” Senator Bragg said.

He added that “right now in Australia, there are next to no delinquencies” – that is, people being forced to sell their homes due to missing consecutive loan repayments.

The question how much financial risk Australia should carry — and whether that extra risk is a price you must pay to allow young Australians to break into the housing market — is being hotly debated.

Should the ‘serviceability buffer’ when people apply for loans be lower?

Australian households are generally more sensitive to changes in interest rates than most other consumers globally.

This is partly because more than 80 per cent of mortgages are on variable interest rates, meaning when the Reserve Bank lifts the official cash rate the mortgage interest rate also rises.

But it’s also because Australia has one of the highest levels of household debt relative to income in the world.

The nation’s banking watchdog, the Australian Prudential Regulation Authority (APRA), told the Senate inquiry, that over the past 20 years, household debt to income has risen from around one and a half times income to about two times.

One of the ways lenders are restricted from allowing Australians to take on too much debt is that, when they assess a borrower for a home loan, they must consider whether that person can meet repayments for the loan at a higher rate.

Currently, the serviceability buffer is 3 per cent. That buffer means that if today, you go to a lender and they offer you a variable rate of 6 per cent, the lender will be assessing your ability to repay the loan at 9 per cent.

Before COVID, this buffer was set lower at 2.5 per cent. A lower buffer naturally means more people can pass through the hurdles set to get a home loan.

The issue is who gets past the goalpost.

When people have jobs, and interest rates are low, how much debt households hold isn’t a catastrophic risk to the financial system. But as those factors change, risks start to build.

In October 2021, banking regulator APRA discovered a concerning trend, and increased the buffer back up to 3 per cent.

It had noticed that hundreds of thousands of Australians had been able to borrow more than six times their income, some on deposits of less than 10 per cent.

While interest rates were still at historic lows of 1 per cent, this wasn’t a big deal.

But, by May 2022, when interest rates started rising, these had now become riskier loans, and stories started to emerge of Australians in mortgage stress

RBA data suggests currently the vast majority of people who have home loans can afford to pay them and aren’t defaulting, but that this could change if more people lose their jobs.

The share of banks’ non-performing housing loans – that is, a loan in which the borrower is in default and hasn’t made any payments of principal or interest after 90 days — has gradually increased from roughly 0.5 per cent in 2016 to about 1 per cent in 2024.

That relatively low default rate is partly why some politicians and some of the big banks think there’s scope to lower the serviceability buffer.

‘Too many hurdles’: First-home buyer says getting finance is hard

For first-home buyers like Ms McLaren in Melbourne, a lower buffer would mean more chance of her being able to get a loan to buy her first home.

She says she only qualified to borrow about $450,000 from the bank based on her income and her parents will lend her the remainder, to help secure a property in the far eastern suburbs for about $600,000.

“A lot of people are just staying home with their parents,” she says.

On the same side of this argument as Ms McLaren are ANZ and National Australia Bank — they say there’s case to ease the buffer to improve access to the housing market.

They are backed by nation’s banking lobby, the Australian Banking Association, and some mortgage brokers and property groups.

ANZ boss Shayne Elliott has argued that while lending restrictions are supposed to protect vulnerable people from getting into too much debt, they can, in of themselves, entrench financial inequality.

He has previously noted that lending has become too restrictive and that “if you want a loan, you have to be better off or you have to essentially be rich”.

But the nation’s biggest bank, Commonwealth Bank, and Westpac differ in their views. They told the inquiry the buffer should stay at 3 per cent to protect against risky lending.

Despite the division between its banking members, the Australian Banking Association (ABA) has called for the buffer to be lowered.

“Current obligations for assessing a first-home buyer’s serviceability do not account for their strong income growth potential, compared to other borrowers,” the ABA’s Chris Taylor told the inquiry.

“Existing regulatory guidance could allow more flexibility for lenders to consider a borrower’s future income growth where it’s prudent to do so.”

Banking watchdog says buffer is needed to protect financial stability

But others, including Australia’s banking regulator and consumer groups say increasing the buffer could create too much ‘risk’ and leave Australians more vulnerable to getting into too much debt and losing their homes.

In percentage terms, APRA-regulated banks have more housing loans on their books than most other comparable countries: About two-thirds of all loans are for housing in Australia.

APRA has stated publicly several times that it thinks in the current market, the buffer should stay where it is.

APRA executive board member, Therese McCarthy Hockey, told the inquiry that the buffer forms part of a broader set of tools to ensure overall financial system stability, not to target any class of buyers.

“And as the data said, it’s holding up and including for first-home buyers.”

Debt helpline financial counsellors are also fighting calls to lower the buffer.

They point a worsening picture of mortgage stress picture now that the Reserve Bank has raised the official cash rate to 4.35 per cent and variable interest rates are hovering around 6 per cent.

Domenique Meyrick, co-CEO of Financial Counselling Australia, says the national debt helpline has received over 42,000 contacts over the past financial year, a 10 per cent increase from the previous year, and that 30 per cent of these calls related to mortgage stress.

“Behind every one of those numbers is a story of a person or a family who’s really at a crisis point,” Dr Meyrick says.

“By the time people are coming calling in experiencing mortgage stress, they have tried everything else, because people prioritise their housing, so they’ll also be experiencing all sorts of other financial difficulty.

Mortgage Stress Victoria chief executive Nadia Harrison also raised similar concerns at the inquiry. She argues that Australia doesn’t face an access to credit issue, but a lack of affordable housing.

“It does appear to be a lazy solution to what is really a much more complicated problem around the need for more supply of affordable housing,” she told ABC News.

“When people are lent money, specifically, large amounts of money — mortgages that they can’t afford — the impacts the costs for individuals are grave.”

Ms Harrison notes that even under the current 3 per cent buffer, many Australians are struggling to afford repayments.

She says while RBA data might show that home loan defaults are only at around 1 per cent, “that really does understate the level of financial strain that people are experiencing”.

“That means that we’ve got higher challenges and problems around credit card debts, buy now, pay later, utilities, bills, all sorts of other things that people are relying on to keep the mortgage repayments up.”

Should banks place less risk on first-home buyers than other types of borrowers?

Banking analyst Jonathan Mott has proposed making it easier for first-time buyers to access credit.

After the global financial crisis, a big change was made to the way banks do business — institutions were ordered to hold more capital for segments of the market that are perceived to be ‘risky’.

Mr Mott is a founding partner of financial services firm Barrenjoey, which made a submission to the inquiry suggesting that APRA should consider rebalancing risk weights to give an advantage to younger borrowers.

A lower risk weighting would be applied for first-home buyers who borrow to build or buy off-the-plan.

Investors and upgraders would attract higher risk weightings.

This, the submission argues, would drive down the interest rate charged to younger customers.

Barrenjoey’s modelling suggests that if you reduce the amount of capital that the bank must hold against first-home buyers by 30 per cent, it reduces the interest rate the first-home buyer pays by 0.29 per cent.

Over the 30-year life of the loan this would save first-home buyers buying new homes about $37,300 in interest on a $600,000 mortgage.

For first-home buyers who buy an existing property, BarrenJoey estimates the interest rate charged would fall by about 0.14 per cent.

This would lead to total interest savings of around $18,100 over the life of the loan on a $600,000 mortgage.

Its modelling also suggests that these potential changes to mortgage risk weights would also lead to a small increase in borrowing capacity for first-home buyers of about 1 per cent to 3 per cent.

Given the pent-up demand by first-home buyers to enter the housing market, Barrenjoey estimates an increase of 30,000 to 50,000 new first-home buyer loans per annum could be possible over coming years, subject to an increase in housing supply.

While some politicians including Andrew Bragg don’t like cross subsidisation and would prefer to reduce the first-home buyer risk weights and leave everyone else unchanged, Barrenjoey suggests that if you did that there would be a very small reduction in the capital requirement for the banking system of less than 1 per cent.

The reason it is that mortgages are a low-risk product to start with (SME and personal loans are much higher risk weights) and it would only apply to new loans, not the existing book of $2.2 trillion of mortgages.

Mr Mott told the Senate inquiry his suggestions are not about proposing a weakening in financial resilience, but making it easier for first-home buyers to break in.

He cited data from Australia’s biggest bank, the Commonwealth Bank, shows that between December 2016 and June 2023, there’s been a 40 per cent reduction in the borrowing capacity of many people trying to enter the housing market.

He also noted that CBA lent almost two and a half times as many mortgages in Australia to owner occupied households earning more than $200,000 than they did to households earning less than $100,000.

Mr Mott also argued the 3 per cent buffer had become “disproportionate” and “a burden for a lot of people”, and suggested it be lowered to 2.5 per cent.

Greens call for rent freezes and an end to property tax breaks

Most stakeholders who have addressed the inquiry over the past few weeks have argued that the solution to housing affordability also relies on supply-side measures – that is, building more houses.

The Albanese government has set out an ambitious target to build 1.2 million new homes over the next five years, although many argue that that is unlikely to be hit amid rising building costs and higher interest rates reducing new home starts.

The debate gets more complicated when it comes to focusing on demand-side measures such as how much people should be able to borrow, and whether housing tax breaks should be scaled back for investors. 

Greens Senator Barbara Pocock says their housing policy focuses on phasing out negative gearing and the 50 per cent capital gains tax discount for property investors as well as freezing rents.

She says lowering the serviceability buffer won’t help solve affordability.

“It’s the wrong solution. It won’t work, and we need to actually face the larger problem of growing affordable supply and protecting renters, and that’s what the Coalition should be looking at, not a tinkering at the edges.”

She says if the banks really want to help first-home buyers, they could consider not charging them mortgage insurance.

“It’s not insurance that actually makes much difference to the borrower, who’s still carrying a great risk,” she notes.

“So there is a case to be made, I believe, for the banks to assist through lowering the costs of mortgage insurance, taking it on themselves.”

The inquiry will hand down its final recommendations in the coming weeks.