ASIC has issued a report on the practice of ‘equity stripping’ (pdf), where fringe brokers refinance vulnerable borrowers in financial stress into loans they cannot afford, in order to earn substantial fees.

This report draws on a qualitative examination of a small number of transactions but offers useful recommendations for both brokers and lenders.

The report recommends that brokers can avoid the risk of arranging refinances that are of no benefit to borrowers by:

• providing realistic information to borrowers in financial stress, including advice that, in appropriate circumstances, their best option is to sell their home rather than refinance;
• only recommending a refinance where that transaction has appropriatelong-term benefits for the borrower;
• making sufficient enquiries to ensure that the consumer can repay the loan, including an assessment of their income and expenditure; and
• disclosing the likely repayments, their fees and the total cost of refinancing in advance of the transaction, so that the borrower can make an informed decision.

ASIC argues that "lenders can reduce the risk of approving applications forwarded by brokers for borrowers who cannot afford loans by:

• regularly reviewing their risk management practices;
• identifying ‘high risk’ applications and patterns of conduct, and monitoring them more stringently (‘high risk’ applications can include refinances where the borrower is in arrears, and, for non-bank lenders providing low doc or no doc loans, refinances of home loans from another lender wherethe circumstances suggest the borrower may be in default);
• using their internal complaints handling procedures as part of this monitoring process;
• assessing the extent to which channelling all communication with the borrower through the broker increases the risk of fraudulent applications (and adopting appropriate risk management practices);
• if the broker arranges valuations for the lender, considering whether the broker is valuation-shopping to ensure the estimate of the property value is sufficient to allow the loan to be approved.

Lenders can also assist existing customers by ensuring that their procedures to deal with borrower hardship are workable, practical, and communicated to their customers so that short-term financial difficulties are managed in a way that reduces the need for the borrower to look to refinance elsewhere."