Borrowers must save for deposits when buying a home but loan-to-value ratios should not be capped: RBA’s Luci Ellis

Australia should not set a cap on loan-to-value ratios (LVRs) but borrowers must raise some kind of deposit when buying a home, says Luci Ellis, head of the RBA’s Financial Stability Department.

“People need to provide some deposit when they buy a home. It protects them if something goes wrong for them, like a job loss or illness, especially if it happens at the same time that housing prices are falling,” Ellis told the Capital Market Dysfunctionality Annual Conference in Sydney today.

Banks typically require a minimum deposit of between 5% and 10% - but higher deposits are needed to qualify for lower rate mortgages.

However, Ellis cautioned against a cap on loan-to-valuation ratios (LVRs) for mortgages, which could be varied from time to time, as has been adopted in some countries.

Ellis also said that a cap would have little impact on those buyers trading up, while squeezing first-home buyers out of the market.

And she cautioned that an LVR cap would not prevent boom-bust cycles in housing prices though she said it was prudent to have “some sort of limit to the leverage in collateralised loans such as mortgages”.

“The alternative would be the situation in the United Kingdom or the Netherlands, where one could borrow as much as 125% of valuation and, more importantly, where many people actually did so, not just a small fringe.

“I don't think that is good practice.”

She said setting an LVR cap below 100% might be sensible for the jurisdictions that have adopted such a policy, but not relevant in Australia where the prudential framework already “requires higher risk weights on high LVR loans, especially those that are not insured”.

Ellis says the evidence from overseas is that setting an LVR cap limits the increase in arrears rates that occurs when the bust comes.

“That is because the borrowers who get into difficulty are more likely to have some equity, even if prices fall. They can therefore sell rather than default.

“That's not a bad thing, but in the end our responsibility for financial stability is about protecting the real economy.

"Protecting the banks from the real economy is not the ultimate goal.”