CBA follows Westpac by slashing stress test for refinancers

In good news for those stuck in "mortgage prison", Australia’s biggest bank, CBA, has announced it will lower the stress test on select refinance applications from 3 percentage points to just 1 percentage point.

By the APRA guidelines, banks are required to subject all new mortgage applications, including refinancing, to stress tests.

But moves by our two biggest home lenders to cut the serviceability buffers they apply to borrowers wanting to refinance could be a sign that we're heading towards peak interest rates – and shows that competition in the mortgage market remains intense.

These tests ensure that borrowers can still afford their loan repayments even if interest rates increase by 3 percentage points above the original rate they applied for.

Consequently, some borrowers, particularly those who purchased properties at maximum borrowing capacity during a period of historically low rates, face difficulties in refinancing to a more affordable lender.

They fail to meet the serviceability test at higher interest rates.

If you think about it a 3 per cent buffer suggests official rates may rise by by 0.25 per cent another dozen times – which seems highly unlikely.

Starting June 23, the Commonwealth Bank of Australia (CBA) has introduced a "Refinance Alternate Assessment" for refinancers who do not pass the bank's standard serviceability test on a 30-year loan term.

This assessment incorporates a 1 percentage point buffer, as long as it exceeds the bank's floor rate, currently set at 5.40 per cent.

For instance, CBA's lowest variable rate for owner-occupiers making principal and interest payments with a 20 per cent deposit stands at 6.34 per cent.

As a result, potential refinancers applying for this loan could be stress-tested at 7.34 per cent instead of 9.34 per cent.

To qualify for this alternative assessment, refinance customers must have a loan-to-value ratio of at least 80 per cent, demonstrating a good track record of debt repayment over the past 12 months, and refinance to a principal and interest loan of a similar or lower value.

CBA allows refinancers to borrow an additional $10,000 or 1 per cent of the loan size, whichever is higher.

It is important to note that the refinanced loan must revert to a 30-year term, which may result in long-term costs amounting to thousands of dollars for some borrowers.

This development comes nearly two weeks after APRA, Australia's banking regulator, reiterated that the buffer was a crucial risk mitigant.

APRA also warned banks to implement any changes to their exception processes prudently on a case-by-case basis.

It is worth mentioning that non-bank lenders are not obligated to adhere to these guidelines.

According to the latest APRA Quarterly Property Exposure Statistics for the March 2023 quarter, 2.8 per cent of all new loans funded by banks were approved outside their standard serviceability policies.

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This translates to $3.76 billion worth of new home loans, including refinancing.

But there's a catch...

CBA's recent move has the potential to assist numerous borrowers in freeing themselves from the burdensome mortgage situation and refinancing their loans at a lower interest rate.

Nevertheless, there is a catch with CBA's new policy: borrowers opting for this refinancing option must extend their loan term back to 30 years.

This extension could have significant long-term implications and result in higher overall costs.

According to research conducted by RateCity.com.au, an individual who secured a $500,000 loan three years ago (in June 2020) from one of the big four banks could witness a reduction of $235 in their monthly repayments if they choose to refinance with CBA's lowest variable rate loan, assuming they have a 20 per cent deposit, as per the new option.

However, due to the extended loan term of an additional three years, this borrower would end up paying an extra $32,117 in interest over the course of the loan compared to not refinancing at all.

Alternatively, if the borrower were to opt for Westpac's lowest rate loan, which currently offers an introductory rate of 5.94 per cent and maintained the remaining loan term of 27 years, they would experience an additional $10 monthly decrease in repayments compared to the "do nothing" option.

Over the life of the loan, choosing Westpac's option would result in interest savings of $45,078 compared to the "do nothing" scenario and a significant $77,195 compared to CBA's option.

These calculations are based on the assumption that the cash rate will rise in line with ANZ's cash rate forecast.

Impact of refinancing and extending out loan term by an additional 3 years

	Interest rate today	Monthly repayments (today)	Interest over remainder of loan
Do nothing	6.75%	$3,159	$579,525
Refinance with CBA back out to 30 yrs	6.34%	$2,924	$611,642
Refinance with Westpac - existing loan term	5.94% (intro rate)	$2,917	$534,447

Source: RateCity.com.au. Notes: assumes person took out a big four bank variable loan with a 20% deposit in July 2020 and has not renegotiated since. Assumes cash rate increases in line with ANZ’s forecast. Westpac’s current lowest rate is an introductory variable loan which rises by 0.40 per cent after 2 years.

RateCity.com.au research director, Sally Tindall, said:

“CBA has followed in Westpac’s footsteps, clearing the way for other banks to start assessing mortgage prisoners at a lower stress test.

Australia’s biggest bank is ready and willing to help refinancers in mortgage prison, but borrowers considering this option should be aware it comes with a costly catch.

Forcing refinancers to extend their current loan term has the potential to cost tens of thousands of dollars over the life of their loan – something that should be considered as one of the last resorts, rather than a first port of call.

What these borrowers need is options, and ideally, ones that aren’t going to come back to bite them in the long run.

While APRA has reiterated its commitment to the current buffer, it has confirmed banks can bend the rules on a case-by-case basis, provided they dot their ‘i’s’ and cross their ‘t’s’ to mitigate any risks.

We expect more banks to tweak their serviceability policies in the weeks to come to help borrowers survive the rate hikes."