You’ve gotta love Australia’s reactive financial regulators.
On Friday, the Reserve Bank of Australia (RBA) released its bi-annual Financial Stability Review, which conceded that lending standards have been weaker than it had first envisaged, led by the prevalence of interest-only mortgages:
While housing lending standards have been better in recent years than in the years leading up to the financial crisis, recent investigations by regulators have revealed that standards were somewhat weaker than had originally been thought. As a result, some borrowers have had less of a safety margin against unexpected falls in income, increases in expenses or increases in interest rates…
In some cases, practices have not met prudential expectations, potentially placing lenders at risk of breaching their responsible lending obligations under consumer protection laws. In particular, poor documentation and verification by lenders in many instances suggests that some borrowers may have been given interest-only loans that were not suitable for them. Serviceability assessments also seem to have been especially problematic: the common (and prudent) practice of applying a buffer to the interest rate used when calculating the allowable new loan size had in some cases been undermined by overly aggressive assumptions in other parts of the serviceability calculations…
The increased prevalence of interest-only lending has been a concern for regulators; these loans can involve greater risk than principal and interest loans because borrowers need not pay down any principal during the interest-only period. For example, ASIC noted in their recent review of interest-only lending that, in the first five years of a principal and interest loan, a borrower making scheduled repayments at current interest rates would typically pay down about 10 per cent of the principal, establishing a sizeable cushion against any fall in housing prices. Anecdotal information also suggests that some owner-occupier borrowers may be using interest-only loans as a means of affording a larger loan.
Now at the 11th hour, the Australian Securities and Investments Commission (ASIC) has released a suite of online tools to help consumers better understand the risks of interest-only mortgages. From Martin North at Digital Finance Analytics:
ASIC Deputy Chairman, Peter Kell, said while ASIC’s review had found that banks and other lenders needed to lift their game to ensure compliance with responsible lending obligations, consumers can help themselves by doing their homework before taking on such a large financial commitment.
‘For most Australians, a mortgage is one of the most significant financial decisions they will make in their lives,’ Mr Kell said.
‘While an interest-only mortgage may be attractive due to their initial lower repayments, they generally cost more in the long run. Some lenders have also started charging higher interest rates on interest-only mortgages compared to principal and interest mortgages.
‘Anyone thinking of taking out an interest-only mortgage needs to have a clear plan of action when the interest-only period ends to ensure they can afford the repayments, which may increase significantly,” said Mr Kell.
Mr Kell suggests consumers who are considering an interest-only mortgage, or who already have one at present, should consider the following:
– ensure you can afford the increased repayments once the interest-only period ends, and also factor in an interest rate rise;
– the principal of the loan will not reduce while you are making interest-only repayments;
– using an offset account to reduce the cost of an interest-only mortgage will only work if you can keep making these extra repayments without making any withdrawals. If you are tempted to dip into your offset account, then you might be better off with a principal and interest mortgage instead.ASIC’s recent probe into interest-only mortgages reinforced the fact that lenders and brokers need to meet responsible lending obligations and ensure the interest-only loans they arrange meet their customers’ requirements and objectives.
‘We expect that lenders and brokers arranging interest-only mortgages would do so in a way that is consistent with their customers’ plans,’ Mr Kell said.
While it’s good to see Australia’s financial regulators finally showing concern about the decline in lending standards, it comes well after the ‘horse has bolted’.
For nearly four years, this site and others have called for macro-prudential controls to prevent high risk mortgage lending, only to then face stiff resistance from Australia’s policy makers, including the RBA’s head of financial (in)stability, Luci Ellis.
Risk management 101 dictates that preventative policies are almost always preferable to reactive policies – something the RBA & co are yet to recognise.
