Property prices are sliding in parts of the country, but the real friction point for buyers right now is happening inside the credit assessment, not the auction room. Lenders are adding layers to serviceability checks, asking for more documentation, and declining applications that would have cleared a year ago. The proximate cause is higher living costs and persistent rate pressure, but the deeper mechanic is risk management around equity erosion and refinance capacity 12 to 18 months out.
Banks are pricing in a scenario where a borrower who settles today at 90 per cent loan-to-value ratio in a softening market may not have enough equity to refinance when their fixed term expires or their discount period ends. That leaves the loan stuck, and the lender exposed if the borrower can’t meet a higher variable rate without the option to shop around. Front-loading scrutiny now is cheaper than managing distressed borrowers later.
Why lenders are tightening now
Mortgage serviceability assessments have always carried a buffer, typically 3 percentage points above the actual loan rate, but lenders are now layering additional checks on top. Expense verification has become granular: rental income needs signed leases and payment history, side income requires ABN registration and bank statements, even regular transfers to family members are being flagged as potential ongoing commitments. The test is no longer just “can you afford this rate plus buffer?” but “will you still have options in 18 months if prices stay flat or fall another 5 per cent?”
The mechanic is straightforward. A buyer purchasing at $800,000 with a $720,000 loan today has $80,000 in equity. If the property drops to $760,000, equity falls to $40,000, just 5 per cent. Refinancing typically requires at least 10 to 20 per cent equity depending on lender risk appetite, so that borrower is functionally locked in. If their current lender then raises rates or removes discounts, there’s no competitive pressure to keep them on a good deal. Lenders are reading this probability into credit decisions now, which means higher income requirements, lower maximum loan sizes, and stricter treatment of discretionary spending.
Wage growth has been running around 4 per cent, but mortgage serviceability is assessed against a floor rate, currently around 9 per cent for most lenders, plus all declared expenses. A borrower earning $120,000 with $2,000 in monthly living costs and no other debts could service roughly $600,000 a year ago; today the same income and cost profile is clearing closer to $550,000 because lenders are treating discretionary spending (subscriptions, dining, travel) as fixed rather than compressible.
The equity trap and what it means for refinancing
Negative equity is the state where a loan balance exceeds the property value. It doesn’t trigger a margin call, lenders can’t force a sale unless you default, but it does freeze your options. You can’t refinance, you can’t access equity for renovations or investment, and you’re captive to whatever rate your current lender offers. For borrowers coming off fixed rates in the next 12 months, this is the scenario lenders are managing for.
The risk is asymmetric. If prices stabilise or rise, the borrower has options and the lender faces normal competitive churn. If prices fall and the borrower is stuck, the lender holds a higher-risk loan with no market discipline on pricing. Front-loading the assessment, declining marginal applications now, shifts that risk back to the buyer, who either needs a bigger deposit, higher income, or a cheaper property.
For first-home buyers stretching to 90 or 95 per cent LVR, this creates a double bind. You’re paying lenders mortgage insurance to cover the deposit gap, but you’re also being assessed under tighter income rules because the lender knows you have no equity buffer. The result is that the marginal buyer who would have been approved 18 months ago is now being told to save another $30,000 or wait for income to rise.
The catch
- Lenders are testing serviceability at rates around 9%, roughly 3 percentage points above current variable rates, but they’re also scrutinising expenses more closely, treating discretionary spending as fixed costs.
- A 5% price fall can cut equity in half for a borrower at 90% LVR, which is enough to block refinancing and trap the loan with the original lender.
- First-home buyers at high LVR are being hit twice: they pay mortgage insurance AND face stricter income tests because lenders know they have no equity cushion.
- Refinancing typically requires 10–20% equity depending on lender risk settings, so even a modest price fall can lock borrowers in for years.
Red flags in the next six months
Watch for divergence between advertised rates and actual approval rates. If lenders are marketing low headline rates but declining more applications, it signals they’re managing volume by tightening credit rather than raising price. Publicly available approval data lags by a quarter, but mortgage brokers will see it in real time, ask your broker what percentage of their submissions are being declined on serviceability versus a year ago.
The second signal is how lenders treat existing customers. If your bank is offering better retention rates than new-customer rates, it’s a sign they’re worried about refinance risk and want to keep you locked in. Conversely, if retention offers are weak, the bank may be confident you can’t leave, because they know the equity position.
Third, watch for policy announcements around responsible lending or credit standards. If regulators tighten serviceability rules further, it compounds the equity trap: borrowers who are already marginal become sub-marginal, and the pipeline of future buyers shrinks. That feeds back into price expectations, which reinforces the original equity risk.
Scenarios and probabilities
Base case: prices drift down another 3 to 5 per cent over the next year, rates stay elevated, and lenders hold current serviceability settings. Buyers at high LVR face restricted choice, and first-home-buyer approvals slow. Refinancing activity stays low because borrowers lack equity or income headroom to switch. No crisis, but a grinding tightness that favours cash buyers and existing owners with equity.
Upside: the RBA cuts twice in the next six months, wage growth accelerates to 5 per cent, and prices stabilise. Serviceability pressure eases slightly, refinancing opens up, and lenders compete for volume again. Still requires income growth to outpace cost-of-living increases, which is uncertain.
Downside: prices fall 10 per cent, unemployment rises above 4.5 per cent, and lenders tighten further. Negative equity becomes widespread among recent buyers, refinancing freezes entirely, and the two-tier market hardens, equity-rich buyers dictate terms, while leveraged buyers are stuck. Default risk stays low (most borrowers can still service at current rates), but equity destruction locks in losses and kills mobility.
Practical steps if you’re applying now
Start by stress-testing your own budget at 9 per cent. If your income is $120,000 and you’re looking at a $650,000 loan, monthly repayments at 9 per cent are roughly $5,200. Add your fixed costs (rates, strata, insurance, utilities, transport, childcare), and see what’s left. If the margin is thin, either lower the loan amount or wait for income to rise, because lenders are running the same test and treating discretionary spending as non-compressible.
Second, prepare full documentation upfront. Lenders are asking for three to six months of bank statements, payslips, tax returns, and explanations for any irregular deposits or transfers. Rental income requires a signed lease and evidence of payments hitting your account. Side income needs an ABN and at least two quarters of consistent deposits. The more your income or expenses deviate from W-2 salary and standard costs, the more you’ll need to explain.
Third, factor in the refinance constraint. If you’re buying at 90 per cent LVR and prices fall 5 per cent, you’re functionally locked in for two to three years unless you can pay down principal or property values recover. That means your current lender’s retention rate in 18 months is your actual cost, not the advertised new-customer rate. If that rate is 7 per cent instead of 6 per cent, the real cost of the loan is higher than the initial approval suggests.
If you’re upgrading or investing, consider whether you have enough equity buffer to refinance even if your new property falls 10 per cent. A 70 per cent LVR loan can absorb a 10 per cent price fall and still leave you at 78 per cent LVR, which most lenders will refinance. A 90 per cent LVR loan at the same price fall puts you at 100 per cent LVR, which no lender will touch. The difference is whether you have options or you’re captive.
For more on how falling prices are shifting investor decisions, see Australia Home Prices Fall As Investor Squeeze Gets Real. If you’re weighing the broader economic backdrop and rate outlook, Australia’s Economy Is Slowing, But the RBA May Not Blink covers the trade-offs.
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General info, not financial advice.
