The Australian Prudential Regulation Authority (APRA) has released consultation revisions to Prudential Practice Guide APG 223 Residential mortgage lending.

APG 223 sets out APRA’s expectations for prudent residential mortgage lending practices, including guidance on addressing credit risk within ADIs’ risk management framework, applying sound loan origination criteria and appropriate security valuation methods, managing hardship loans and establishing a robust stress-testing framework.

The revised APG 223 includes more detailed guidance on the following areas:

• quantitative serviceability parameters including the application of interest rate buffers and floors, haircuts for non-salary income such as rental income, treatment of interest-only loans and estimation of living expenses; and
• other qualitative measures including meeting responsible lending obligations, monitoring serviceability policy overrides, and treatment of self-managed superannuation fund loans and other specific loan types.

Responsible lending

The Guide states that failure to meet responsible lending conduct obligations, such as the requirement to make reasonable inquiries about the borrower’s requirements and objectives, or failure to document these enquiries, can expose an ADI to potentially significant risks.

APRA expects that any material changes to an ADI’s serviceability policy would be analysed and the potential
impact on the risk profile of new loans written would be reported to appropriate risk governance forums. Reference to competitors’ policies as the primary justification for policy changes would be seen by APRA as indicative of weak risk governance.

The Guide states that it would be prudent for ADIs to monitor the level of, and trends for, lending to borrowers with minimal income buffers. APRA expects that ADI serviceability policies should incorporate an interest rate buffer of at least two percentage points. A prudent ADI would use a buffer comfortably above this.

Prudent serviceability policies should incorporate a minimum floor assessment interest rate of at least seven per cent. APRA expecs a prudent ADI would implement a minimum floor rate comfortably above this.

Reliance solely on Household Expenditure Measure (HEM) or the Henderson Poverty Index (HPI) in loan
calculators to estimate a borrower’s living expenses generally would not meet APRA’s requirements for sound risk management. APRA expects ADIs to use the greater of a borrower’s declared living expenses or an appropriately scaled version of the HEM or HPI indices.

Interest-only loans

For interest-only loans, APRA expects ADIs to assess the ability of the borrower to meet future repayments on a principal and interest basis for the specific term over which the principal and interest repayments apply, excluding the interest-only period.

SMSF loans

APRA considers that the nature of loans to SMSFs gives rise to unique operational, legal and reputational risks that differ from those of a traditional mortgage loan. In performing a serviceability assessment, ADIs would need to consider what regular income is available to service the loan and what expenses should be reflected in addition to the loan servicing.