Taking out a home loan to buy a property is a significant decision for most people. Property is such a large, lumpy asset it usually requires a commitment for many years into the future.
The first step is going to a bank, building society or credit union and applying for the loan. An investor recently bought a property at auction – a little unexpectedly – and so had to quickly get to the bank Monday morning.
The good news was the loan was approved without issue. The investor’s reaction, though, was informative on a different level.
"The bank approved it so it must be ok," he said.
That will hopefully prove to be the case. But banks and credit institutions are in the business of lending money. Naturally they carefully manage bad debt situations but that is done from the position of managing their business risk – not necessarily a consumer’s personal risk – although they do have obligations to understand their client’s circumstances.
This investor clearly took comfort from the fact the loan had been approved, which raises the question of just how much weight an investor/consumer should assign to a credit institution’s decision to lend you money.
Regulator ASIC released in August a review of home lending practices specifically focussing on interest-only loans which typically are favoured by investors.
The results were concerning in that it exposed some poor practices among the 11 institutions who had their loan files reviewed.
Property valuations in Australia are widely acknowledged as being high, and housing demand remains strong.
ASIC particularly focussed on interest-only loans because the proportion of interest-only loans has been rising dramatically since 2012. According to the ASIC report, in the March quarter of 2015 interest-only loans accounted for more than 40 per cent of new home loans.
ASIC makes the point that interest only loans are more expensive over the long-term when compared with principle and interest loans as investors are effectively trading off lower upfront repayments while accepting higher costs in the longer-term.
One of the findings of the review was that most interest-only loans are written through broker/third-party channels. More concerning was that in 40 per cent of the files ASIC reviewed, the affordability calculations made were flawed – they assumed investors had longer to repay the principal than they actually had.
Possibly of more concern was that in 30 per cent of cases there was no evidence that lenders had considered whether the interest-only loan met the consumer’s requirements, while in 20 per cent of cases the consumer’s expenses/income had not been taken into account.
Not surprisingly, ASIC described the results as "poor", particularly as almost all of the 11 lenders reviewed did not keep sufficient records on an investor’s circumstances and objectives.
The ASIC report provides six findings on areas where lending practices can be improved to ensure the market is operating efficiently and fairly and clearly there are ongoing concerns about poor lending practices in relation to interest-only loans.
ASIC is also concerned that investors may be committing the mistake of being overconfident in their ability to make higher repayments in the future. In light of this, ASIC is urging investors to carefully consider whether interest-only is the appropriate loan arrangement for them.
ASIC is doing its job in highlighting poor practices and requiring licensees to raise their standards but consumers/investors also need to play their role in understanding the commitments they are making.
Certainly, it seems relying on the lender’s approval to validate your decision could prove cold comfort indeed.
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Robin Bowerman is Head of Market Strategy and Communication, Vanguard Australia. As a renowned market commentator and editor Robin has spent more than two decades writing about all things investment. |
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