© Provided by ABC Business Michelle is buying a house and land package that fits within her budget. (ABC News: John Gunn)
Michelle Winata wanted to enter the property market, but not get in over her head or be unable to travel while she’s still young.
“I did want to maintain my lifestyle, and the holidays that I did choose were very budget,” she told the ABC.
A teacher from Western Sydney, Michelle has been able to save money by living with her parents, who were supportive of her property ambitions.
“My family all invests in property, my sister bought her first house when she was 18,” she said.
With the help of a mortgage broker, Michelle settled on a house and land package that would allow her to get a foot in the door without being overburdened.
Michelle has no other debt burdens, low expenses and a full-time job, so she wouldn’t be considered a high-risk case, but her broker and her bank still need to make sure they are complying with responsible lending laws.
And that doesn’t just mean a simple calculation of income minus expenses.
What is an unsuitable loan?
Banks, lenders and brokers are governed by responsible lending obligations set out in the National Credit Act.
These laws, in place for a decade, require lenders and brokers to not provide or recommend credit products that are unsuitable for a customer.
An unsuitable loan could be one a borrower can’t afford to repay, or can only repay with substantial financial hardship — for example, a monthly mortgage repayment that means a borrower can’t pay their electricity bill.
Or it could be a product that doesn’t fit with a borrower’s objectives — for example, a credit card with a $20,000 limit when the customer only wanted a $2,000 credit card to purchase some flights.
Responsible lending was at the heart of the banking royal commission and, while Commissioner Kenneth Hayne did not recommend changing the law, he did find it wasn’t always being followed.
He also noted that a crucial test case on responsible lending was still before the courts at the time of his final report, brought by corporate regulator ASIC against Westpac.
In a much anticipated ruling, the Justice Nye Perram found that thousands of home loans made by Westpac weren’t irresponsible, despite using a relatively low benchmark rather than customers’ actual living expenses to assess the loans.
However, ASIC is appealing that decision, further muddying the waters for lenders about the standard that is expected as they await the final outcome from the court.
In the meantime, ASIC has released updated guidance, which it says is “principles-based”, with the aim of showing what actions a lender might take in particular circumstances to meet their responsible lending obligations, but not prescribing what has to be done in every case.
What questions should a bank or broker ask?
ASIC’s new guidance includes a slew of detailed, very specific examples that lenders may encounter.
Karen Cox from the Financial Rights Legal Centre has welcomed that approach.
“Some of those are cases are very like ones we’ve seen here at this service,” said Ms Cox, who leads the centre, which runs the National Debt Helpline.
“Everyone thinks ‘that won’t happen to me’, but when you see the circumstances in which these things happen it becomes so much more real.”
Some of the examples included in the update are:
- Requesting a cancellation letter from a streaming service, if someone says they’ll give up their subscriptions to afford a small loan
- Asking whether a would-be borrower is willing to move their children from a private to a public school
- Making sure a food delivery driver is earning enough income to make repayments over several months, not just relying on one week’s payslip
As those examples illustrate, ASIC is guiding lenders to confirm whether customers have made changes they said they would, if they are necessary to afford the loan.
“If the consumer will need to make spending reductions and lifestyle changes to meet the financial obligations of the credit product, you may need additional information to enable you to determine whether the credit product will meet the consumer’s requirements or objectives,” ASIC said.
“There may be some lifestyle changes the consumer would not be prepared to make to afford credit.”
“This is an important document for the industry to guide each bank’s approach to responsible lending which we will now study closely to assess any impacts it may have on borrowing for customers,” said Australian Banking Association chief executive Anna Bligh.
Concerns about ‘tick the box’ compliance
Justice Nye Perram’s judgement in the Westpac responsible lending case has become known by its most headline-grabbing line.
“I may eat Wagyu beef everyday washed down with the finest shiraz but, if I really want my new home, I can make do on much more modest fare.”
The crux of the case was Westpac’s use of the Household Expenditure Measure — a relatively low estimate of basic living expenses — in loan assessments, instead of the customer’s actual declared expenses.
Using the fine-dining example, Justice Perram said that “knowing the amount I actually expend on food tells one nothing about what that conceptual minimum is”, and argued the “conceptual minimum” is what is crucial in determining whether borrowers can actually make loan repayments.
“I think there’s this whole complicated debate on now in light of the Westpac case around the concept of belt-tightening,” said Financial Right’s Karen Cox.
She has some concerns that unscrupulous lenders will ignore individual customers’ circumstances.
“If I look at someone’s statements and see that they’re spending a lot of money … and consistently overdrawing their account, then to what extent should I be able to say to them ‘oh, you’re willing to give up this service, and this service, and this service, because if you do you’ll be able to afford this loan’ and that’s the end of the story?
“It certainly is where there is the risk of the ‘tick to box’ type approach, where you say ‘sign here that you’re willing to give up the following’, which won’t actually assist consumers in the long run.”
While she agrees about the wine and the wagyu being optional items, Ms Cox cites other spending that may not be captured in benchmarks but are considered necessities by certain borrowers, for example, additional schooling for a child with a disability.
For its part, ASIC said the responsible lending obligations are intended to strike a balance between “the goals of minimising the incidence of consumers entering unsuitable credit contracts, and the goal of maximising access to credit for consumers who have the desire and ability to service it”.
For Michelle Winata, that balance meant purchasing land and building a house in another city, taking on a more affordable mortgage than if she had tried to jump straight into the Sydney market.
“Ideally the ultimate goal is that I can sell it and then buy a house in Sydney, because at the moment the Sydney prices are just too crazy,” she said.