Investment homes under scrutiny

The Reserve Bank views loans on investment properties as riskier in the event of a downturn. Photo / Janna Dixon

The Reserve Bank has taken a step closer to treating residential investment properties differently from owner-occupied ones for prudential purposes, a policy with potential consequences - as yet unquantifiable - on the interest rates banks will charge landlords.

The Reserve Bank is consulting banks on how best to define a residential investment property loan. It proposes the new asset classification for such loans will take effect from July 1 and that all existing loans be "classified correctly" by April 1 next year.

As for the implications for interest rates, that is a matter for negotiation between borrowers and their banks, it says.

"The proposed asset class rule may affect the amount of capital that the banks need to have as backing for some loans, which may affect pricing."

The consultation document gives no indication of how much higher the risk weighting on investment properties would be than the 30 per cent normally given to residential mortgages.

The Reserve Bank has abandoned, after consultation with the banks, an earlier proposal of a test based on the number of properties a borrower owns (initially four, then five).

One option now is to count every property which is not owner-occupied as an investment property.

That raises the difficulty of cases where someone owns more than one residential property and splits his or her time between them. It would also capture more properties than the count-based test. A second option would be to define investment properties on the basis of whether rental income the property generates is to be used to service the loan. In that case, would it be if it covered more than half the cost, or should depending on any rental income be the test?

The consultation document is non-committal on whether the Reserve Bank is inclined to any of these options in particular.

The feedback it seeks relates to the practicalities and compliance costs involved for the banks.

The bank also proposes to set a higher LGD or loss given default weighting to residential investment loans than it already does for residential mortgages. It is a variable in calculating how much capital a bank has to have to cover such loans and it would vary with the loan-to-value ratio (LVR).

These proposals reflect the bank's view that loans secured on investment properties are riskier in the event of a severe housing market downturn.

It points to evidence from Ireland's crash that default rates were significantly higher among investors than home buyers.