A divergence in serviceability buffer requirements between Australia's banks and non-bank lenders impacts credit risk profiles and competitive dynamics within the mortgage market, Fitch Ratings said in a report on Friday.

Regulated banks are required to apply a 300-basis-point buffer above the mortgage rate, while most non-banks use a buffer of 200 basis points. However, for like-for-like refinancing, some nonbank lenders use a buffer as low as 100 basis points above the prevailing rate. Some even qualify borrowers at a 0% buffer if the borrower's financial position is improved.

The Australian Prudential Regulation Authority confirmed the setting of a 3% buffer in July. This requirement applies to banks, and non-bank lenders have adopted a more flexible approach since 2021, with most reducing their serviceability buffer to 2% and subsequently, some cutting the buffer even further for like-for-like refinancing.

This has resulted in non-bank lenders attracting marginal borrowers who may not meet the stricter criteria set by banks. This has become a feature of Australia's mortgage market, and it shapes origination volume and the risk profiles of borrowers unable to pass serviceability assessments with a 3% buffer.

The National Consumer Credit Council introduced a targeted "like-for-like" concession in 2019, allowing eligible "mortgage prisoners," those unable to refinance to lower-rate loans due to their inability to meet the higher serviceability assessments, to refinance loans at a lower interest rate, provided the new repayments are lower and performance conditions are met. The concession applies a reduced serviceability buffer, most commonly 1%, determined on a case-by-case basis.

The ratings firm said that it adjusts foreclosure frequency to reflect the increased credit risk when assessing mortgage portfolios containing like-for-like refinanced loans using lower buffer rates.