The Australian Prudential Regulation Authority (APRA) has flagged lowering the minimum interest rate serviceability buffer from 7 per cent to a level determined by banks and other lenders.

The removal of the interest rate floor comes amid falling house prices, record-low credit growth, and expectations that the Reserve Bank will cut interest rates this year. The cash rate is currently at an all-time low of 1.5 per cent.

For the past four-and-a-half years, APRA has required banks to test prospective borrowers against the higher of either an interest rate of 7 per cent, or a 2 per cent "buffer" over the loan's actual interest rate, to ensure they could meet repayments if rates rise.

The regulator also asked banks to ensure borrowers were "comfortably" above these thresholds, which has meant most banks test whether customers can manage repayments if interest rates hit 7.25 per cent, which is much higher than the actual mortgage rates, currently sitting below 4 per cent for many owner-occupier borrowers.

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However, APRA chairman Wayne Byres said with interest rates at record lows, and likely to remain at historically low levels for some time, the gap between the 7 per cent floor and actual rates paid "has become quite wide in some cases — possibly unnecessarily so.

"In addition, the introduction of differential pricing in recent years — with a substantial gap emerging between interest rates for owner-occupiers with principal-and-interest loans on the one hand, and investors with interest-only loans on the other — has meant that the merits of a single floor rate across all products have been substantially reduced."

The proposed changes, while likely to increase the maximum borrowing capacity for a given borrower, "are not intended to signify any lessening in the importance that APRA places on the maintenance of sound lending standards," Mr Byres added.

"Rather, it is simply recognition that the current interest rate environment does not warrant a uniform mandated interest rate floor of 7 per cent across all products."

APRA says proposed change gives 'flexibility'

In a letter to authorised deposit-taking institutions (ADIs) issued on Tuesday, APRA said ADIs could be permitted to review and set their own minimum interest rate floor.

However, ADIs would need to apply a mandatory interest rate buffer of 2.5 per cent.

Mr Byres said the operating environment for ADIs had evolved since the current serviceability assessment was introduced in December 2014, prompting APRA to review the "appropriateness" of the current guidance.

APRA has also faced lobbying on this issue from Australia's major banks, which all saw their share prices increases more than 1 per cent in morning trade on the prospect of a change, following much bigger gains yesterday on the surprise return of the Morrison Government.

Mr Byres said the proposed changes will provide ADIs with "greater flexibility to set their own serviceability floors, while still maintaining a measure of prudence through the application of an appropriate buffer to reflect the inherent uncertainty in credit assessments".

A four-week consultation will close on June 18, ahead of APRA releasing a final version of its updated guidance that will need to be followed by banks.

Change could see more Aussies get a mortgage

Market experts say the change could increase peoples borrowing capacity and thereby see more people take out a mortgage.

Cameron Kusher from CoreLogic said the proposed APRA changes "seem sensible given the interest rate environment with the expectation that rates will fall from here and remain lower for longer.

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"Furthermore, since 2014 it has become much more difficult to get a mortgage, which is partly because of this serviceability assessment," he said.

He said the proposed changes were welcome and, if implemented, "will help some borrowers that can't quite access a mortgage currently to get one".

While it will remain much tougher than in the past to get a mortgage because of other areas of tightening, he said "overall, for the housing market it will mean more people are able to get a mortgage.

"These proposed changes in conjunction with the uncertainty of the election now behind will potentially provide additional positives for the housing market.

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