The financial regulator has warned the nation's banks not to let lending standards slip in an environment of cheap credit, saying borrowers must be prepared for higher interest rates.
As the $1.2 trillion mortgage market heats up, an official audit of lending standards by banks and other lenders has highlighted areas where the sector could lift its game.
The warning by the Australian Prudential Regulation Authority came amid signs the housing market is starting to move ahead with prices posting their strongest quarterly gain since the end of the 2010 boom.
The national dwelling value rose 4 per cent in the three months to August, the highest rate of capital gain since April 2010, right before the last boom began to fizzle, according RP Data-Rismark figures released this month. Sydney dwelling values shot up 5.4 per cent over the quarter and values in Melbourne rose 4.8 per cent.
Economists are still tipping the Reserve Bank may cut official cash rates as early as November to help spur growth through the economy as mining investment slows.
An audit of the nation's banks by APRA concluded lenders had policies in place to make sure borrowers could service their debts, but it also identified areas where banks could improve their internal processes when approving home loans.
The audit, conducted this year, assessed the debt-servicing policies used by 27 banks and other authorised deposit-taking institutions in home lending.
Some of the key areas for improvement were: banks should look more closely at borrowers' other debts; some assessments of borrowers' living expenses were too simplistic; and, in a minority of cases, some mortgage documentation was incomplete or inaccurate.
The regulator's report said it was "critical" for banks to maintain a strong focus on making sure borrowers could service their debts when interest rates rose. "Low interest rates can mask debt serviceability assessments, creating opportunities for borrowers to increase their leverage," it said.
It said banks and other deposit-based lenders needed to carefully monitor the debt-servicing capacity of their borrowers "over the duration of housing loans, not just at origination to ensure that borrowers are able to manage the transition to higher interest rates, when that inevitably occurs".
A separate article from APRA said there had been an increase in the number of higher-risk loans of 90 per cent or more of the property's value.
Last month New Zealand moved to rein in a hot housing market, imposing limits on low-deposit/high-value loans. Regulators often view restrictions on the amount of high loan-to-value ratio lending as an effective macro-prudential tool in controlling the housing market.
Commonwealth Bank chief executive Ian Narev recently said he did not lie awake at night worrying about how Australia's property market might respond to record-low interest rates.