This week, we saw another version of the tug of war at play in Australia’s residential property market.

House prices have soared in most parts of Australia in the last 18 months. Almost certainly, one of the key causes has been low interest rates. Low rates allow people to borrow more. In times when demand outstrips supply, increased borrowing capacity quickly becomes increased actual borrowing. In turn, higher borrowing means higher actual spending on houses. Prices rise.

As we wrote in last week’s newsletter, it now takes an Australian working full time for the average income about 12 years to earn enough, after-tax, to buy an average-priced Australian home. This does not include the interest paid on debts – it is simply the purchase price of the property.

This is worth remembering because, while interest rates might be low, borrowers still need to repay the actual amount borrowed. The price of the house has to be paid for, so anything that raises prices means it will take longer to earn the money to finance the purchase.

By any measure, housing is currently expensive. This is why the Australian Prudential Regulation Authority (APRA) this week introduced a change to the way lenders can lend. This may well become just the first of a range of measures designed to reduce people’s ability to borrow and spend on housing.

The change is a simple one. At present, when assessing a potential borrower’s ability to service a loan, lenders are ‘expected’ to add 2.5 percentage points to the rate being proposed when assessing repayment capacity. So, if someone is considering borrowing at 3%, the lender needs to assess how much debt they could service if rates rose to 5.5% when deciding how much can be lent.

As of the end of October 2021, lenders will need to use a rate 3.0 percentage points higher. So, if someone is applying for a loan at a rate of 3%, the lender needs to assess their repayment capacity using a rate of 6%.

This will reduce the amount people can borrow. One estimate is that borrowing capacity will fall by around 5%. Assuming people are borrowing 80% of the purchase price of a property, this would reduce the amount they can spend by 4%.

This is an example of Government policy working to restrict demand for housing. It is a welcome one, although it will obviously affect people on lower incomes, who are probably more likely to be first home buyers, more than others.

Unfortunately, APRA’s attempt to reduce demand puts the regulator into a tug of war with various other arms of Government. APRA is trying to reduce demand. But there are various programs and Government initiatives that also aim to assist people to buy homes – by increasing spending capacity, and thus drive demand. One that was announced just this week is in Victoria, where the state government proposes to become co-owners of around 3,000 properties by providing up to 25% of the purchase price of a property. The purchaser needs only to come up with the first 5% of the purchase price. The State Government’s 25% ‘stake’ is paid off over time. Effectively, while it does not say as much, the State government is lending money for housing.

The effect of this must be greater demand for housing, which will increase prices. Victoria’s move is not an isolated example. NAB’s website lists five different types of Government ‘assistance’ for property buyers – all of which actually drive demand because they increase the amount that people can spend on a property.

And so, we get our tug of war: APRA is trying to pull prices in one direction while other arms of Government strive for the opposite result. Time will tell whose arms are stronger, but people wanting to buy homes should be barracking for APRA. A win for APRA would save people years of hard work.