ASIC has published its Review of interest-only home loans (REP 445) which sets out ASIC’s findings from a review of home loans with an interest-only period during the initial part of the loan. The key findings and recommended actions for lenders and brokers focus on responsible lending obligations which apply to all types of loans.
ASIC conducted a review of over 140 individual interest-only home loan files over a 3 year period from 11 lenders, including both ADI and non-ADI lenders, who offer interest-only home loans which are regulated by the National Credit Act. The files reviewed related to home loans for both owner-occupiers and residential property investment. The licensees either provided credit through mortgage brokers, directly to consumers, or through a combination of channels.
ASIC conducted the file reviews in collaboration with APRA, to enable both regulators to gain an in-depth understanding of practices for interest-only home lending, and to view the issues from both a prudential and conduct regulation standpoint.
ASIC’s principal finding is that lenders are often failing to consider whether an interest-only loan will meet a consumer’s needs, particularly in the medium to long-term when there are higher repayments after the initial interest-only period ends.
ASIC expects all lenders to review their procedures in light of its findings to ensure they are meeting their obligations. ASIC says that RG 209 and its other work in this area has set out clear guidance and ASIC considers that lenders have had ample opportunity to ensure their practices are compliant.
ASIC says that where it identifies breaches of the law, it will consider enforcement action or other appropriate regulatory action.
Responsible Lending Key Findings
The review found examples of practices that, in ASIC’s opinion, place lenders at risk of breaching responsible lending obligations.
In particular, ASIC found that:
(a) in 40% of the files reviewed, the affordability calculations assumed the borrower had longer to repay the principal on the loan than they actually did (by using the full term of the loan to calculate principal repayments, rather than the residual term);
(b) in over 30% of files reviewed, there was no evidence that the lender had considered whether the interest-only home loan met the borrower’s requirements; and
(c) in over 20% of files reviewed, lenders had not considered the borrower’s actual living expenses when approving the loan, but relied instead on expense benchmarks.
Finding 1: Lack of evidence of inquiries into requirements and objectives
Nearly all lenders in the review did not keep sufficient evidence of inquiries into consumer’s requirements and objectives when entering an interest-only home loan. While requirements and objectives for an interest-only home loan may be more apparent for investors, ASIC said it is not always clear how an interest-only home loan meets the requirements of an owner-occupier. In most cases there was no information stating the reason an interest-only home loan had been selected.
Finding 2: Affordability and interest-only home loans
Lenders did not always ensure that the consumer had sufficient income (i.e. an appropriate income surplus) above their expenses and loan repayments, so that they could withstand a reasonable fluctuation in income or expenses or an interest rate rise. There was substantial variation in how lenders applied interest rate buffers. Some lenders applied a buffer to the proposed loan only and not to existing debt that may also be affected by interest rate rises.
Finding 3: Variation in treatment of volatile and irregular income
There was variation between how lenders treated volatile and irregular income sources. ASIC found examples in the file reviews of the higher income figure being used for serviceability assessments where there was a substantial difference between previous years’ incomes. ASIC said rental income is typically discounted by 20% to allow for property expenses and periods of non-occupancy. However, ASIC saw examples in the file reviews where the property-related expenses would likely be greater than 20% of rental income.
Finding 4: Lack of evidence of inquiries into expenses and reliance on benchmarks
ASIC found that, in general, lenders did not demonstrate that they had made sufficient inquiries into a consumer’s expenses and relied heavily on expense benchmarks to estimate living expenses. ASIC says expense benchmarks are not a replacement for proper inquiries into a consumer’s actual expenses.
Lenders were using the following practices (which, in ASIC’s view, makes it unlikely they were complying with their responsible lending obligations):
(a) Relying on an expenditure benchmark—Some lenders relied on a benchmark rather than conducting inquiries into the consumer’s actual expenses.
(b) Ignoring information provided by the consumer—Three lenders stated that they always used an expenditure benchmark when assessing the consumer’s ability to service the loan, even when the consumer’s declared expenses were higher than the benchmark.
(c) Requesting information about expenses in a way that was simplistic or ambiguous—Some lenders asked consumers to state their expenses as a lump sum, or to only state their basic expenses, without any explanation as to what was meant by ‘basic’. ASIC considers these approaches may result in lenders not obtaining accurate information.
Finding 5: Capacity to pay after interest-only period not based on residual-term payments
A number of lenders calculated affordability using repayments that are artificially low, as they are based on principal-and-interest repayments being made over the full term of the loan, rather than the residual term remaining after the interest-only period. This practice increases the risk to borrowers with longer interest-only periods.
Finding 6: Lack of flexibility for hardship variations for interest-only home loans
ASIC found that financial hardship policies for most lenders did not distinguish between interest-only and principal-and-interest home loans. However, a small number of lenders applied more restrictive options for borrowers seeking hardship variations under an interest-only home loan.
Response by lenders
Table 1 contains 10 recommended actions by lenders.
ASIC says that all 11 lenders that were included in the review have advised ASIC that they intend to change, or have already commenced the process of changing, their practices in this area. For example:
(a) all lenders (in addition to the four who already use this method) have committed to move to assessing interest-only home loans using the ‘residual term’ method of calculating repayments;
(b) all lenders (in addition to the one who introduced this practice in December 2014) have committed to moving to use an income-adjusted benchmark when considering a consumer’s expenses; and
(c) most lenders who offered longer interest-only periods have committed to reducing the maximum interest-only period offered to owner-occupiers to five years.
