The architect of a crucial safeguard designed to protect the banking system from the risk of a widespread mortgage crisis says it should never have been abolished by the financial regulator.
As the head of credit risk at the Australian Prudential Regulation Authority (APRA), Glenn Homan oversaw the introduction of a serviceability "floor" in 2014, as part of the regulator's attempt to rein in risky lending that was fuelling a runaway housing market.
That floor meant lenders began assessing borrowers' ability to make repayments against a minimum of 7.25 per cent interest. It ensured that, if they procured their loan in a "lower-interest-rate environment" — like the one during the pandemic — they were not caught out when those rates rose.
However, the interest rate floor was scrapped by APRA in 2019, after lobbying from the banking sector.
Its removal was welcomed by then-treasurer Josh Frydenberg "as a positive development" that would "spur lending growth".
It was a move that, Mr Homan said, with some benefit of hindsight, had led to a "bad outcome" for many Australians who had cashed in on the COVID-19 property boom and were now facing financial hardship as interest rates returned to historically average levels.
"The borrowing public needs some form of hedge against rising rates … they need some sort of protection," Mr Homan told ABC Investigations.
Mr Homan — who left APRA in 2016 to join the private sector before retiring this year — said the floor was a safety net for many borrowers who did not have the financial literacy to make accurate assessments of their future incomes and trusted the financial institution to advise them on what they could afford.
"It was designed to not have people over-gear themselves too much," he said.
"I think it's been almost frightening that people, in their own mind, don't have a sense of what the maximum mortgage is that they want or [that] they're comfortable with.
"They have had a tendency to rely on the lending shop to tell them … 'Why borrow $500,000, when you can afford, you know, $1 million?'"
He added the serviceability minimum was there to also protect lenders beyond just "a point in time" and to "keep the longer-standing credit quality of mortgage portfolios at a prudent level".
Across his four decades in the financial sector, Mr Homan observed lending institutions pushing borrowers to their absolute limit if the prudential regulations permitted it.
Lenders directly dealing with customers also often had commissions and bonuses tied to the volume of loans they gave out.
"I think people have been encouraged [by lenders] to really try [to] borrow the supposed maximum they can afford against the serviceability model that any particular organisation uses," he said.
The floor was derided by the banking sector. ANZ chief executive Shayne Elliott complained that it forced the lender to turn away one in five loan applications.
Two days after the 2019 election that saw the Morrison government secure another term, APRA chair Wayne Byres announced the regulator had written to banks proposing the floor be dumped.
He then appeared in a public meeting with Mr Frydenberg, who backed the move and told banks they had an "economic and social responsibility" to lend.
An APRA spokesperson told ABC Investigations its decision was not influenced by external lobbying or pressure.
To compensate for the removal of the floor in 2019, APRA increased the existing buffer used to stress-test a potential borrower's ability to make repayments to 2.5 per cent above the rates offered by lenders. This was raised in October 2021 to 3 per cent.
It also expected lenders to set their own floor.
Between the period when the floor was scrapped and the buffer was increased to 3 per cent, home lending roughly doubled.
During COVID-19, some fixed rates on loans dropped to as little as 1.59 per cent.
However, in the coming 12 months, those ultra-cheap fixed rates are set to expire and borrowers will end up at the so-called mortgage cliff, whereby a move to variable rates could see their monthly repayments more than triple.
University of Sydney economist Stephen Whelan said when regulations loosened, banks were incentivised to lend more, which led to customers taking out bigger loans, often to invest in property.
He said it was "unwise" to not have serviceability requirements such as the floor during historically low-interest periods.
"The [serviceability floor was] about looking after bank customers … but also ensuring that financial institutions remained sound and that they didn't face, in the event that interest rates rose, a large number of customers [who] would default on their loans," Professor Whelan said.
"If you had asked any economist what was going to happen to interest rates, unanimously they would have said they're going to go up."
He said the watering down of regulations led to a change in the "power dynamic" between lenders and borrowers.
While the banks were lending more, it also shifted the onus of responsibility to the customer to make sure they could service the debt over the life of the loan.
Professor Whelan said this translated to further risks for banks if a large enough proportion of customers began to default on their mortgage.
An APRA spokesman told ABC Investigations: "Banks were still expected to use a floor, but APRA's new guidance allowed them to set their own level, which APRA monitors to ensure it is prudent."
"APRA's reasoning for moving away from the 7 per cent level was that the floor would have been too high as rates declined — the gap between the floor and actual rates paid by borrowers would be unduly wide and unnecessarily restrictive to credit," the spokesman said.
He added the emergence of different products — such as lower rates for owner-occupiers than for investors — made a single-figure floor unfair and that multiple floor levels were "unduly complex".
Mr Homan was not convinced by this argument, characterising it as a "little bit convenient".
He questioned how challenging it would have been for lenders to manage.
However, he acknowledged that he was not at APRA when the 7 per cent floor was removed.
Mr Homan said during his time at APRA he ran up against many bankers, including those in executive positions, who believed "anything that APRA did that got in the way of lending was inherently a bad idea".
Despite the impending so-called mortgage cliff, APRA said its latest figures from December 2022 showed more than 99 per cent of mortgage holders were meeting their repayment obligations.
However, financial counsellors also report many borrowers are cutting back on essentials, including food and heat, to manage their loans.
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