The Australian financial marketplace is not short of legislation to protect consumers from predatory or irresponsible lending practices.
The National Consumer Credit Protection Act 2009 provides a comprehensive set of legal guidelines requiring lenders and brokers to make reasonable, verified enquiries to ensure that consumers can comply with their financial obligations if the loan is given.
In addition, it gives consumers a cause of action to seek compensation against lenders or brokers where the statutory obligations are not met, usually after they have fallen into unmanageable mortgage debt.
Together with the Australian Consumer Law, the industry has had a robust legal framework from which to navigate its responsible lending practices and minimise the risk of consumers falling into default by biting off more than they can chew – and to help guard against a US style mortgage debt crisis which can harm the broader economy.
However, consumer lawyer, Josh Mennen, believes that in spite of these laws, irresponsible lending practices have been rife over the past decade amid a booming property market and record low interest rates..
In the last year, Josh who heads up the financial services disputes team at plaintiff law firm Maurice Blackburn Lawyers has seen a sharp increase in legal inquiries from bank customers who are unable to meet their repayment obligations for investment property mortgages.
“Property investment in Australia is somewhat of a national sport. However, we are now seeing the ugly side of this sport, with a significant number of investors in unmanageable debt – defaulting on their mortgages, losing their investment properties and or family home and in severe cases facing bankruptcy”, Josh told us ahead of the Responsible Lending & Borrowing Summit.
“The statutory consumer protections have been trumped by a systemic sales culture within the banks that is tilted towards getting loans approved as countless consumers’ seek to ride the property boom. This has been on stark display in the Banking Royal Commission. The challenge for Commissioner Hayne is to effect change in an environment which already has a rigorous legal regime in place..
Forgetting what we already know
For many years, the world has felt the effects of systemically poor lending practices played out on a major economic scale in the USA.
The consequent subprime housing market collapse and global financial crisis (GFC) ought to have been a major wake-up call for banks and investors alike. Yet, a mere decade later and we are seeing similar trends, albeit on a smaller domestic scale, as economic conditions change and already over-committed investors tip into default, according to Josh’s analysis.
“In recent years, we have observed free, loose lending practices in our major banks, amid a booming property market and record low interest rates”, he said.
“Many property investors have successfully managed their repayment obligations while riding this property wave. But the wave is due to crash soon and it’s not going to be pretty.
“There have already been clear signs that the property market is entering a sustained period of decline”, he continued.
“We have had the lowest auction clearance rates in Sydney and Melbourne that we have seen for many years and there is a real concern that this will get worse, particularly if interest rates rise which is likely”.
The mortgage debt time-bomb
Josh’s recent report, The Mortgage Debt Time-Bomb points to some frightening statistics, which suggest a significant debt over-commitment in Australia, threatening the state of the wider economy.
“According to 2015-16 Australian Bureau Statistics, 29 percent of Australian households are classed as over-indebted, that is, debt which equates to 75 times the value of their assets”, said Josh.
“Concerningly, just a 1 percent increase in interest rates would push 40 percent of homeowners in Australia into mortgage stress.
“Distress sales are already on the rise. With just a slight increase in interest rates, thousands of property investors may be in financial crisis, looking at the prospect of bankruptcy”.
On top of this, foreign investment in Australian real estate has fallen off a cliff as China clamps down on foreign investment outflows and due to tighter restrictions on foreign property buyers in Australia.
“Chinese investment had been a major stimulus to the Australian property market and its dial down is part of the falling property market mosaic”, warns Josh.
The perfect storm
Perhaps even more of a worry is a recent study by the UBS, led by Jon Mott, which suggests that $500 billion worth of Australian home loans (18 percent of all Australian credit) is based on inaccurate or unreliable information.
“For example, sometimes we see applications in which a person’s annual income figure is inclusive of a bonus. But bonuses are inherently unreliable and should not be used for credit assessment purposes”, Josh told us.
“In turn, we have seen many instances where banks, who are then required to verify the financial information that they receive, are not going and checking tax returns and source documents which underpin the representations made in an application.”
These types of so called “liar loans” are a case of “rubbish in, rubbish out” and, in conjunction with other factors they create the “perfect storm” for an economic crisis, Josh explained.
The use of benchmarking tools in credit assessments is also a concern.
“Benchmarking tools have been misused as a proxy for determining consumers’ household expenses. The result has been that they inaccurately pigeonhole applicants into understated household expenses which allows an approval for excessive credit.
“The benchmarking tool used most prevalently is the HEM (household expenditure measure) developed by Melbourne University. The tool wasn’t specifically developed for credit assessment purpose, but banks have built it into their automated loans assessment systems as a determining metric when in reality people tend to spend much more, and it is an unreliable substitute for actual expenses that skews the outcome towards unsustainable debt approval”.
Prevention rather than cure
Josh doesn’t believe that adding an extra layer of regulation is the right course of action.
“The legislation is already there. What we need is systemic change that addresses the root causes of irresponsible lending.
“If the threat of punishment doesn’t appear to be deterring these practices, then perhaps it is time to rethink the nature of remuneration incentives which promote them in the first place”.
“The widespread use of interest only loans has been another key ingredient in the loan default trend we are seeking. These are an easier sell for a broker, because the initial repayment figure is lower. They also maximize trailing commission by stretching out the repayment period.
“However, when the interest only period ends and the loan tips into principal and interest, that’s when the issues arise.
“During this period a repayment amount can increase by around 40 percent which can easily throw a household into hardship – and is doing so, as we are now seeing the maturation of these loans”.
Continuing the conversation
Josh Mennen is in the process of lobbying for change which has included submissions to the Banking Royal Commission and consultation with politicians.
Continuing the conversation Josh will present at the Responsible Lending & Borrowing Summit to be held 4-5 March 2019 in Sydney.