Credit …. Not so easy ?

In what could be the most under reported legislative change in Australian history, new consumer protection legislation came into effect on January 1st 2011 which seems to suggest that the days of “easy” credit are over.

Access to credit has become more difficult with enforcement from this week of new laws that demand greater scrutiny of borrowers from credit card, mortgage and personal loan providers.

The laws are part of the National Consumer Protection Package and place a greater onus on lenders and brokers to ascertain that their customers are able to repay loans and meet lending costs.

The new laws cover may aspects of consumer protection, and responsible lending is just one of them. The governments’ glossy brochure on the changes is here and has some remarkable content and iconography.. Look they have got a beautiful baby !!

Responsible lending has two core elements

  • if a loan is considered to be unsuitable for a consumer; and
  • if they do not have the capacity to repay the loan, they will not be provided with the loan

This is new ? Prior to this new legislation it was ok for Australian lenders to issue loans to people knowing they couldn’t pay them back ? Really ? That could explain some of the things we have witnessed over the previous decade, but surely that wasn’t enshrined in legislation.

The major parts of the latest legislation are that the lenders or lending assistants must:

  • provide a credit guide that discloses information about the lender, including all fees, charges, interest and commissions they will receive.
  • not provide, suggest, or assist with a credit contract that is unsuitable for the consumer.

Again we have to ask why this is new, have lenders been able to provide unsuitable credit contracts to people prior to January 1st 2011?

A much more detailed version of the latest changes is the explanatory memorandum and again it contains some interesting reading.

Chapter 3 – Section 3.5

The key obligation for licensees is to ensure they do not provide, suggest, or assist with a credit contract that is unsuitable for the consumer. This obligation requires licensees to reasonably inquire and verify customer’s financial circumstances to make an assessment that the credit contract will meet the consumer’s requirements and that the consumer has the capacity to repay the contract.

Section 3.8

The May 2008 final Productivity Commission’s report on the Review of Australia’s Consumer Policy Framework (the PC Report) noted an increased use of credit in Australia over the last 20 years. Increased use of credit has led to higher levels of household indebtedness which impacts on household financial capacity and ability to respond to changing circumstances such as interest rate increases, a slowdown in economic conditions or rising unemployment. Evidence suggests that these increases have come about mostly as a result of the growth in the size of home loans over the years.

Section 3.17

The Code contains a provision that imposes ‘up front’ obligations on any party to a credit transaction. These obligations set out that ‘a person must not a make a false or misleading representation in relation to a matter that is material to entry into a credit contract or a related transaction or in attempting to induce another person to enter into a credit contract or related transaction’. This places accountability on all parties to a credit transaction, borrower, credit assistant and lender alike to conduct themselves honestly and transparently.

Section 3.65

In order to appropriately meet the requirement to make an assessment about the unsuitability of a suggested contract for the consumer or of a contract application in relation to which they are providing assistance, the credit assistant must:

  • make reasonable inquiries about the consumer’s requirements and objectives for the credit contract;
  • make reasonable inquiries about the consumer’s financial situation; take reasonable steps to verify the consumer’s financial situation; and make any inquiries or take any verification steps as prescribed by the regulations.

This certainly reads like it should improve credit standards, especially if any of these things were actually allowed previous to this new legislation; and we applaud this legislation if this is the case. However, if that is true then this is pretty terrible news for lenders and the housing market because it just adds to the other lack of drivers for new debt issuance. This could however explain why it has been so under reported.

We would be interested to hear from any of the finance professionals or lenders in our audience to get their version of what this actually means.


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Comments

  1. Hi there,

    I am WA-based and have some experience in the financial services industry.

    WA has had fundamentally similar laws to the new Federal system for a number of years now – a response to our finance brokers scandal of a decade ago, whereby unscrupulous brokers convinced thousands of naive retirees to pool their money into mortgage lending schemes which subsequently blew up… I guess it was a bit like the HIH collapse, in that *sure* you'd rather not have had it in the first place, but at least once the brown stuff hits the fan you can spot some of the flaws and try to tidy them up… Why the rest of Oz didn't do this at the same time is beyond me, but better late than never, hey?

    Anyhoo, I got myself a Finance Broking licence under our "old" regime a year or two ago — not because I'm a dodgy commission-guzzling broker, but because the extent to which my peers were gearing themselves to the eyeballs gave me the heebie-jeebies and I wanted to provide some more balanced advice. Having said that, once KRudd introduced the FHOB and prices went (even) wild(er), all bets were off…

    I've sat on the sidelines ever since then, waiting for ASIC to resolve all the uncertainty over what would change / when / etc. To be perfectly honest, even though the "new" regime is now up and running, I would respectfully suggest that a lot of the uncertainty still hasn't been cleared up in the minds of many licensees… Just wait to read about the brokers who *thought* they were licensed and continued to write loans, only to subsequently find out that they shouldn't have been?! It's only a matter of time…

    Anyhoo, I'm rambling a bit here… The bottom line is that, yes, brokers AUSTRALIA-WIDE now need to make a far higher level of enquiry than was previously the case… Once upon a time, everyone pretty much just assumed that the loan would be paid back out of capital gains whereas now *god forbid* brokers are going to have to demonstrate how their client can (i) service their monthly obligations; and (ii) do so in a not unreasonable manner.

    Clearly, this can only be a good thing BUT as you point out at the end of your article, it comes with an unintended (albeit IMHO welcome) consequence — downward pressure on prices… After all, if we restrict access to finance for the, shall we say, more marginal borrowers then the logical outcome will be fewer buyers competing for more properties.

    As to why these changes have been underreported thus far, I'd like to think that it's not a case of things being swept under the carpet… To be honest, I think that everyone involved in the process (from ASIC to lenders to peak broking bodies and so on) has been struggling to meet a deadline that has already been extended once and they still haven't got their heads around everything just yet.

    Perhaps once they all know exactly what is going on THEN we might start hearing more about it? eg. When prices continue their descent and vested interests start kicking and screaming about reversing some of the changes…

  2. Any tightening is welcome. Up until recently, copious amounts of credit were foisted on anyone who could mist a mirror.

  3. I posted on these laws a few days ago and as a finance broker (mainly cars as I am not yet experienced enough to do other assets) I can tell you they are complete and utter bollocks. First of all, it doesn't say anything about the affordability guidelines that lenders can use, lenders are still lending almost all the way down to the Henderson poverty line. So it won't make lending any more or less responsible. Lenders were ALREADY legally required to have evidence of a consumers income before offering them a loan.

    I already made 'reasonable steps' to ensure that people could afford the loan before applying. Not out of any moral need to do the right thing, but because lenders just don't approve loans unless they think consumers can afford them. For all the talk about lenders lending irresponsibly (which they certainly have been in the housing market) they sure as hell haven't been doing it for car loans.

    As for fees and charges, they were ALREADY disclosed. Everything was on the loan contract and we were already legally obliged to give all consumers a copy of said contract BEFORE these laws. The complete idiocy comes when we have to disclose any POTENTIAL (as in not what we actually get, what we might possibly get) commissions fees and charges that we can get.

    Responsible lending is great and we should be doing it, but when one party have to disclose potential fees and charges up front AND get the customer to sign off on it, the law it just idiotic. All it will do is cause more people to go to dealers, the very people who rip customers off in the first place!

    Even when the government TRY to do the right thing they mess it up.

  4. Economic Delusion

    Thanks all for comments,

    Sam thanks for the long comment, it certainly added a lot of information to help explain the where and why's of this new legislation.

    Matt, I understand you point about additional unnecesary paperwork especially if customers can simply go down the road to be ripped off by someone who doesn't fall under the legislation, that sounds like a lobby group got involved in the political process; I think you actually said something like that that in your previous comment.

    Although working in car finance I would have assumed that you always had to make sure the person could actually pay the loan back because very few cars appreciate in value.

    Houses on the other hand have. So "sub-prime" lending practices were possible because as Sam said in his comment

    "Once upon a time, everyone pretty much just assumed that the loan would be paid back out of capital gains "

    If this has been going on, then it is going to catch out many people as the market deflates.

  5. "Although working in car finance I would have assumed that you always had to make sure the person could actually pay the loan back because very few cars appreciate in value"

    True, however, aren't home loan borrowers in Australia still required, in all instances, to show evidence of their ability to repay the loan? Wasn't a substantial cause of the US sup-prime mess stated income or 'liar' loans (along with the obvious housing bubble)? Which are already not allowed in Australia? (Please let me know if this is right as I don't work with any mortgage brokers so I wouldn't know).

    As such, without stricter guidelines on capacity, such as 'this person/families living expenses are this, their excess income is this, you can lend them x% of said excess' isn't the whole process pointless? Banks already require proof of income and ability to repay, so I would have thought the biggest problem was allowing them to lend all the way down to the henderson poverty line. Not whether or not you can prove capacity.

    These laws seem like nothing but an exercise in greater bureacracy and pointless extra paperwork. In a time when the country desparately needs stricter consumer lending standards (especially in residential lending), the government has done nothing but create the illusion of them.

    To most lenders/brokers, these laws simply create more pointless paperwork, most of which will simply be back dated at settlement, thus completely and utterly pointless and a giant waste of administration funds.

  6. Another really interesting thing about the new ASIC regulations is that, as things currently stand, it could cripple the "reverse mortgage" industry.

    I don't know how many retirees (or soon-to-retire Baby Boomers) planned to use a reverse mortgage to draw down on the equity in their home (their biggest asset) to fund their retirement, but I would suggest that it's a decent chunk of the market (particularly those who don't have a big whack in their super account).

    My understanding is that, under the new Regs, the broker/lender will need to be satisfied that the borrower can service their loan obligations out of income… And it goes without saying that there isn't much of that floating around in retirement?!

    Perhaps even more interesting, how will the changes affect borrowers who are in the prime of their working life? ie. between 45 and 55

    Sure, they can service their monthly obligations comfortably now, but will they need to show sufficient income earning potential in 10-20 years time (ie. when they planned to retire), in order to continue servicing their obligations under a 25-30 year mortgage ?

  7. I have some experience in housing finance and see the new legislation as tightening things up at the margins. The old style low-doc loans where borrowers just wrote down a number (their income) and signed it are now a thing of the past under this legislation (you will at least need to provide some skeric of supporting evidence now – a BAS statement, an accountant, a bank statement).
    And using all of a borrowers' income to service the loan, down to the Henderson Poverty Line is starting to be looked by regulators (ASIC) with a dubious eye.
    Sam's point about on-going ability to service the loan through the entire term is still an extremely grey area, and also touches upon the monster asleep in the corner which in my view is interest-only loans and particularly ones where the loan never amortises (known as line of credit loans, equity release loans, etc etc). These are massively prevalent and there will be heaps of borrowers who for one reason or another have never amortised much of their loan (and plenty of these who negatively amortise by refinancing into a bigger loan every three years), that will come to the twilight of their working life with a reduced income and no hope of continuing to repay other than by selling up their homes. Given the noises being made by ASIC about ensuring that the loan can be repaid (prncipal too!) it seems to me that if ASIC stays the course on this one, they must start questioning the interest-only culture and that will cause everyone (borrowers and lenders alike) some pain.

  8. Economic Delusion

    I agree , excellent and informative comments. It will be very interesting to see how this is "actually" implemented and what overall effect it has on the credit markets.

  9. I was a mortgage broker when they where introducing all the new reuirements. Like the previous poster WA brokers have been under this regime for some time.

    Aiming at more disclosure the regulations won’t tighten lending criteria as these things are dictated by how risk averse the insurers and reinurers are at the time.

    Furthermore there are strict policies regarding income and what they will accept.

    the loans you are describing are called lo-doc loans. only around 2 % of all loans fit into this catagory from memory.
    Limited to self employed borrowers only this type of loan can only be accessed without proof of income (just a quick check for abn and gst registration)if they have 40 percent equity. if they have less (20-40 percent equity. the loan requires mortgage insurance. Part of the Insurers policies are that BAS statements are submitted in the application. under 20% – take a walk.

    So – yes credit will be harder to get and possibly more expensive, but not because of the new legislation , but a variety of other factors too complex to comment in short.