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ACL Holders and Applicants Take Note – Regulator Scrutiny of Interest-Only Loans and Responsible Lending Practices

In March and April 2017, ASIC and APRA announced they have initiated additional supervisory and surveillance measures to ensure lenders and mortgage brokers are complying with their responsible lending obligations in relation to interest only loans.

All Australian Credit Licence (ACL) holders have an obligation to ensure they do not suggest or assist a consumer to apply for a credit contract if that credit contract is unsuitable for the consumer.  In an environment where many interest only-loans are clearly more expensive than principal-fees-and-interest loans, lenders and mortgage brokers have a responsibility to carefully consider the implications of providing borrowers with interest-only loans.

All ACL holders, in particular mortgage brokers and lenders, must ensure they regularly review and update their responsible lending policies to ensure the products they are providing are suitable for the consumer’s needs.

As a result of this increased scrutiny, Sophie Grace has seen additional rounds of questions from ASIC during the ACL licensing process, with ASIC requesting detailed information about the applicant’s serviceability assessment tool including justification for the net income and interest rate buffers set.

Just this month, APRA stated that it expects banks and lenders to implement measures to reinforce sound lending.  As a result, we are encouraging our clients (even those only regulated by ASIC) to implement the following:

Interest-only lending

Limit the flow of new interest-only lending to 30 per cent of new residential lending. APRA views a higher proportion of interest-only lending in the current environment to be indicative of a higher risk profile of a firm, and we expect ASIC will take a similar view. As ASIC increases its scrutiny of the sector, we expect to see additional requirements on an ACL holder if the proportion of new lending on interest-only terms exceeds 30 per cent of total new mortgage lending.

ACL holders should implement strict and closely monitored risk limits ensuring LVRs on interest-only lending are at 80 percent or below, and ensure there is strong scrutiny and justification of any instances of interest-only lending at an LVR of above 90 percent.

Additionally, when assessing interest-only loans, ACL holders should assess the ability of the consumer to meet future repayments on a principal-and-interest basis when the interest only period ends.

Investor lending

Ensure lending to investors is managed in such a manner to comfortably remain below

APRA’s advised benchmark of 10 per cent growth, which APRA considers an appropriate constraint in the current environment and to continue to restrain lending growth in higher risk segments of the portfolio (e.g. high loan-to-income loans, high LVR loans and loans for very long terms).

Serviceability Assessment

ACL holders must review and ensure that their responsible lending serviceability metrics, including interest rate and net income buffers are set at appropriate levels for current conditions.

This involves improving practices for enquiring about expenses to determine the consumer’s financial situation and capacity to make repayments. A consumer’s actual figures for expenditure for different categories (e.g. food, rent, entertainment etc.) must be collected rather than obtaining aggregate monthly living expenses and then relying on benchmark figures to assess suitability. In addition, ACL holders must ensure the consumers have adequate monthly net income surplus of not less than $200 per month (APRA have noted although they have not yet set a quantitative expectation for net income buffer, they will monitor closely those who lend to borrowers with a net surplus income of less than $200 per month, we expect ASIC to set similar expectations).

It is also expected ACL holders include various buffers in their serviceability assessment models to reflect potential increases in mortgage interest rates. A buffer should be applied over the loan product interest rate that reflects the potential for interest rates to change over several years. APRA considers an interest rate buffer of at least 2 per cent above the loan product rate to be suitable in the current environment.

ACL holders are expected to periodically consider whether they should adjust these buffers to reflect the current lending environment.

ASIC has noted that it expects lenders to individually review cases of hardship and to determine whether they have been impacted by shortcomings in the lender’s past lending practices. Where appropriate, consumers will be provided tailored remediation, which may include refund of fees and interest.

As part of this targeted industry surveillance, ASIC will continue with enforcement procedures against breaches of responsible lending obligations. For example, ASIC has commenced proceedings in the Federal Court against Westpac as they allege the bank did not adequately assess whether borrowers could meet repayment obligations, consequently breaching their responsible lending obligations under the National Credit Act.

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