Impact of Rising Interest Rates on Borrowing Capacity (Australia, June 2025)

Exploring the Effects of Economic Shifts on Property Investment

Interest Rate Trends and Current Levels

Australia’s official cash rate climbed from 0.10% in 2021 to a high of 4.35% by late 2023 as the RBA battled inflation.
In 2025, the RBA has pivoted to an easing cycle, reducing the cash rate to 4.10% in March and further to 3.85% in May.
Major banks anticipate gradual cuts toward a 3.35%–3.85% range by year-end, with potential for slight declines in 2026 if inflation remains subdued.

Serviceability Criteria and Stress Test Buffers

The Australian Prudential Regulation Authority (APRA) mandates a 3% buffer above the actual loan interest rate to stress-test borrowers’ repayment capacity. For example, a home loan quoted at 6% is assessed at 9% when calculating affordability, ensuring borrowers can withstand future rate increases.

Practical Example

Assuming:

Gross salary: $100,000/year
Rental income: $2,000/month (80% counted)
Living expenses: $3,000/month
Existing debt repayments: $1,500/month

Total assessed income: $9,933/month. A $500,000 loan at a 9% serviceability rate requires repayments of $3,959/month. With total commitments of $8,459, the debt-to-income (DTI) ratio hits 85%, surpassing the typical 50–60% lender threshold.

Why Borrowing Power Has Fallen

Every 0.5% rise in interest rates cuts borrowing capacity by roughly 5%.
Since 2022, Australians’ borrowing power has dropped by about 40%.
The 3% stress buffer remains a key constraint despite recent rate cuts.

Potential Changes and Outlook

There is industry debate over reducing the buffer from 3% to 2.5%, which could boost borrowing power by around 5%. Regulators, however, proceed cautiously to maintain financial system resilience.

Tips to Improve Serviceability

Pay down or refinance existing debts.
Document stable rental income.
Increase your deposit to lower the loan-to-value ratio (LVR).
Compare offerings from major banks, regional lenders and non-banks.

Summary Table (June 2025)

Metric	Value / Status
RBA Cash Rate	3.85%
Typical Home Loan Rate	~6%
Serviceability Buffer	3% (assessed at ~9%)
Borrowing Power Impact	–40% since 2022
Preferred DTI Ratio	50–60%
Buffer Reduction Impact	+5% borrowing capacity

Conclusion

Although the RBA has begun trimming rates, elevated borrowing costs combined with the mandatory 3% stress buffer continue to limit Australians’ borrowing power. These safeguards support financial stability but also constrain home ownership opportunities.

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