The financial regulator will lift restrictions on interest-only residential lending from January 1 in an attempt to stabilise Australia's ailing housing market.

The Australian Prudential Regulation Authority (APRA) imposed the restrictions in March 2017 to force lenders to limit new interest-only lending to 30 per cent of home loans that they issue.

Australia's median property price experienced its sharpest drop since the global financial crisis earlier this month, with capital city values falling 0.9 per cent.

Sydney and Melbourne, the capitals that enjoyed the biggest property booms, were hit hardest — falling by 9.5 and 5.8 per cent from peak to trough.

It is the second lending restriction APRA has relaxed this year.

In April, the regulator removed a "speed limit" that it had imposed on lenders since 2014, requiring them to keep investor credit growth below 10 per cent each year.

"APRA's lending benchmarks on investor and interest-only lending were always intended to be temporary," APRA chairman Wayne Byres said.

"Both have now served their purpose of moderating higher risk lending and supporting a gradual strengthening of lending standards across the industry over a number of years."

The difference in borrowing costs between owner-occupier and interest-only loans widened after APRA's restrictions. ( RBA, JP Morgan )

The regulator touted its success in reinforcing "sound lending practices".

"The introduction of the benchmark has led to a marked reduction in the proportion of new interest-only lending, which is now significantly below the 30 per cent threshold," APRA wrote in a statement.

Not a 'monumental' change

But property analysts believe APRA's latest move will have very little impact on property prices, which are expected to continue falling in most states.

"I don't know these changes are really that monumental," CoreLogic's head of research Cameron Kusher told ABC News.

"If you look at lending to interest-only borrowers, it's [already] sitting at about 16.5 per cent of new lending, when the cap is 30 per cent."

"What it might do is make it easier for people who are coming to the end of their interest-only mortgages — or are getting into financial hardship — to refinance with a normal lender, without going to the non-bank sector."

The level of interest-only borrowing has fallen since APRA introduced restrictions in 2017. ( RBA, JP Morgan )

Borrowers could potentially benefit from cheaper interest-only loans, said JP Morgan's chief economist Sally Auld.

"Interest-only loans were repriced quite significantly [higher] in the wake of this regulation, so there will likely be some reduction in rates for these loans," she said.

"But with dwelling prices still falling ... and lending standards tighter, marginally lower rates will unlikely result in a quick acceleration in interest-only lending."

Mr Kusher believes any major changes to the industry will happen after the banking royal commission releases its final report in February.

"I'm a little bit surprised the announcement has come out before we got the final report," he said.

"Maybe it's just a case of APRA wanting to provide some good news to the market before Christmas."

Follow David Chau on Twitter @chaudave.