• 10/10/2024

Time for a crackdown on ‘liar loans’ to douse home price bonfire

Jessica Irvine| Sydney Morning Herald| 5 October 2021

https://www.smh.com.au/business/the-economy/time-for-a-crackdown-on-liar-loans-to-douse-home-price-bonfire-20211004-p58x3g.html

Since deciding to become a property investor, I’ve experienced a range of emotions, including both guilt and pride – don’t let anyone tell you it isn’t possible to feel two conflicting emotions at the same time.

Both, however, have given way in recent weeks to the overwhelming force of FOMO – fear of missing out – resulting in a desperate race to find the best way to load myself up with as much cheap debt as possible.

I figure the more I borrow, the bigger property I can purchase, which, on any given percentage gain, will deliver me the biggest dollar return.

I am not alone.

Amid rapidly inflating home prices, all borrowers face a massive incentive to leverage to the hilt – out of necessity for home buyers and, for investors, to ensure maximum returns.

As Reserve Bank assistant governor Michele Bullock put it recently: “When prices are rising very rapidly and there are expectations that this will continue, borrowers are more likely to overstretch their financial capacity in order to purchase property.”

Turns out, I am exactly the type of borrower regulators are now considering trying to rein in.

Having attended a meeting of the council of financial regulators last month, we’re now told the Treasurer, Josh Frydenberg, wants a crackdown on very high debt-to-income loans. This, by the way, from the same Treasurer who last year tried to axe national responsible lending laws to make it easier for banks to write loans, but was blocked by crossbench MPs, including Pauline Hanson.

OK, Josh. I’ll believe it when I see it.

But if I do, despite my personal skin in the game, I will welcome any so-called “macro-prudential policies” – additional restraints on borrowing – regulators decide to take.

Because when you’re standing by a raging fire, it’s only prudent to try to douse the flames.

Of course, a truly prudent firefighter would also consider why the fire started in the first place. In this case, a combination of generous tax concessions, barriers to supply and ultra-low interest rates have created an incendiary mix.

Still, tighter lending rules are better than nothing. And, as I’ve discovered in my recent loan hunt, there exists considerable room to tighten things up quickly, if we choose.

As most borrowers know, when you apply for a loan, the lender must assess your ability to “service” it – that is, to meet the required ongoing principal repayments and interest charges.

Your ability to service a mortgage depends crucially on your net monthly income – the difference between your income and monthly living expenses – and the cost of borrowing – that is, interest rates.

If the cost of borrowing falls – as it has – you can afford to service a bigger home loan from a given net monthly income.

Of course, it also matters that you can keep paying the loan if interest rates rise.

Banks used to “stress test” borrowers to make sure their income, net of living expenses, was big enough to meet interest costs of 7 per cent. In 2019, that was relaxed to a “buffer” of at least 2.5 per cent above the loan’s current rate. Today, that commonly means something just above 5 per cent. Commonwealth Bank recently increased its stress test to 5.25 per cent.

Basically, the higher this rate, the smaller loan you get. So increasing this buffer is one of the ways regulators could slow credit growth.

They may also, as New Zealand has done, simply impose a cap on the proportion of a lender’s loan that can be written at high debt-to-income ratios – of six or more. Many lenders already activate additional checks on borrowers applying for high debt-to-income ratios. Such a cap could catch investors like me, but could also trip up highly indebted first-home buyers entering the market.

As for the bank’s assessment of a person’s net monthly income, I see considerable scope to crack down.https://omny.fm/shows/please-explain-1/how-the-mortgage-war-for-your-home-loan-is-heating/embed?background=f4f5f7&description=1&download=1&foreground=0a1633&highlight=096dd2&image=1&share=1&style=artwork&subscribe=1

Currently, banks are required by responsible lending laws only to make “reasonable inquiries” into a person’s “financial situation” to ensure that the loan they walk away with is “not unsuitable”. Mortgage brokers are also under obligations to make sure the loans they arrange are in the “best interests” of clients.

But since a landmark legal decision by Justice Nye Perram in the famous “Wagyu and Shiraz” case, it’s less clear how much interrogation of potential borrowers’ actual living expenses banks need to perform.

As Perram mused in his judgment: “I may eat Wagyu beef every day washed down with the finest shiraz, but, if I really want my new home, I can make do on much more modest fare.”

Even before that decision, estimates of living expenses provided in loan applications in Australia have tended to cluster around a figure known as the “Household Expenditure Measure”, developed by and regularly updated by the Melbourne Institute, paid for via subscription by the banks and not made publicly available.

It describes a modest level of living expenses which excludes private school fees, strata fees, overseas holidays and health insurance, for example. Both lenders and mortgage brokers are known to steer borrowers towards giving it – or something close – as the estimate of their living expenses to boost their potential borrowing power.

According to the latest “liar loans” survey released last month by UBS, the share of home loans on which people freely admit their information has been “misstated” has risen to 41 per cent, up from 27 per cent in 2015.

Someone really ought to be keeping us honest. I could murder a Wagyu steak right now.

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