Ever since the National Consumer Credit Protection Act became law on 1 July 2010, lenders are required to ‘dig deep’ into a borrower’s financial situation and loan requirements.

ASIC (Australian Securities & Investments Commission) calls these requirements Responsible Lending Guidelines, which every lender must follow when assessing loan applications.

This is from ASIC Regulatory Guide 209: Responsible Lending Conduct:

The credit contract must be not unsuitable for the borrower, which means that:

(a) the lender must make reasonable enquiries about both the borrower’s requirements and objectives and their financial situation; and

(b) the lender must take reasonable steps to verify the borrower’s financial situation.

In short, the lender must ask the borrower two important questions:

Why do you require the loan? The answer is obvious when buying a property – the loan is required to pay the purchase price. Refinancing is the grey area, especially loan increases to pay out credit card debt, tax debt and business debt (known as debt consolidation). Loan increases to pay out debt are more risky than loan increases to build a home extension or to buy a property investment.

What paperwork do you have? Paperwork is needed to prove that the income and expense figures in the loan application form are correct. For example, to prove income, 2 most recent wage slips, group certificates and last year’s tax return / tax assessments might be needed for a salary earner. Two years financial accounts, BAS statements and tax returns / tax assessments might be needed for the self employed. To prove expenses, 3 to 6 months of bank statements, credit card statements, loan statements and tax debt statements might be needed.

Read on to find out why non-banks offer easier loans

For borrowers – It’s all about presenting your loan application in its best light

This checklist mirrors the loan application assessment process.

Credit Files

Black marks on your credit file will harm your loan application Most Australians have an individual credit file. Lenders, utilities, businesses and debt collectors who are members of a credit reporting agency record defaults on the customer’s credit file. For instance, with Veda:
- Minor defaults, such as an overdue phone bill, an electricity bill, a gas bill, are recorded if they remain unpaid for more than 60 days. An overdue loan repayment or credit card payment is recorded if it is more than $150 and is overdue for more than 14 days.
- Defaults/black marks such as court judgments, writs and summonses, loan defaults (which includes overdue accounts), and credit enquiries are recorded for 5 years.
- Serious credit infringements such as bankruptcy, personal insolvency agreements, being a director of a liquidated company, or a ‘clear-out’ (i.e. being uncontactable for 6 months) are recorded for 7 years.
  
  If a default is paid, it can be overlooked by the lender. But it cannot be removed from the credit file until the time period expires, unless it was recorded in error.
Check your credit file before you apply A black mark on your credit file may mean that your loan application is rejected or your loan amount is limited to 80% or your interest rate is higher. To check your credit file, order a free credit report (once each year) or order a paid credit report complete with a credit score (anytime). A credit score rates your creditworthiness compared with the general population – better than 40% is good, better than 60% is very good and better than 80% is excellent.
Don’t shop around for loans Shopping around – making loan applications with many lenders - results in high numbers of credit enquiries in a short space of time on your credit file. Multiple credit card applications and card limit increases in a short time also have this effect. These signal a poor credit risk. If in doubt, choose a good mortgage broker who will make one enquiry.
Make loan repayments on time Positive credit reporting was introduced for credit files in March 2014. Lenders can record loans, loan amounts and limits, credit history and missed payments – if more than 14 days late. These are recorded on the credit file for 2 years.

Click here for Why missing a credit card payment makes it harder to qualify for a property loan.

Serviceability

Serviceability – what income is counted? A stable employment history (at least 1 year) and a stable residential address (at least 3 years) make for a better credit risk. Permanent is better than casual, and full-time is better than part time, when it comes to salary income. There is no income during maternity leave. Income records for the last 2 years are needed to prove self-employed income. Rental income is included, but usually at 80 cents in the $1, to allow for vacancies and repairs. Centrelink payments are not ‘income’. Different lenders have different rules for income serviceability – this is where a good mortgage broker can help.
Serviceability – what expenses are counted? Loan serviceability calculators estimate living expenses, but lenders need to investigate actual living expenses.
Clearing car loans, personal loans, and credit card debt will boost the loan amount because the repayments are expenses. For example, saving $650 per month in repayments increases the loan amount by $100,000 (30 yr loan, 6.5% interest). Serviceability is calculated inclusive of the loan repayments, which are calculated at a ‘stress test’ interest rate of up to 2% above the lender’s standard rate. Some non-bank lenders improve serviceability by structuring loans as interest only for the first 5 years, then principal and interest for 25 years.
Apply for a home loan before you turn 52 Lenders apply age discrimination for over 50 year olds. This is because responsible lending obligations mean that lenders must be satisfied that the borrower with a 30 year home loan has an exit strategy to repay the amount outstanding at age 65, when they retire. Superannuation balances and other assets will satisfy this requirement. This ‘rule of 52’ does not apply to investment loans or to personal guarantees.

Loan Products, LMI & LVR

Save on LMI (Lenders Mortgage Insurance) LMI is expensive – it can be $1,800 for each $10,000 borrowed above 80% of the price / value. It is usually deducted from the loan advance. Some non-bank lenders don’t require LMI – instead they charge an equivalent fee and cover the risk themselves. LMI is insurance which protects the lender if the borrower defaults – it provides no protection to the borrower. Having a 20% deposit means that no LMI is needed.
Loan-to-Valuation Ratio (LVR) limits The location, zoning and type of the property all affect the LVR for a property loan. Lower LVRs in the range 60% to 80% LVR apply to new apartments, to non-residential property zoned commercial or rural, to vacant land, and to SMSFs (Self-Managed Superannuation Funds). LVR is applied to value, not purchase price. For example, if the price is $500,000, and the valuation is $475,000, then a loan with an 80% LVR will be $380,000 not $400,000. If so, the borrower needs to fund the $20,000 shortfall.

80% LVR limit applies to investment loans, home loans to self-employed people and SMSFs. Lenders use lower LVRs when they are tightening lending requirements. For example, many lenders are applying a 70% LVR limit for loans on new off-the-plan high rise apartments.

If the property is located in a town or place with less than 10,000 people, the major banks will not lend at all. A good mortgage broker can help here.
Loan products with review clauses and overdrafts are high risk The standard 30 year housing or investment loan is a low risk loan for a borrower because it does not have a review clause. Lenders cannot ask for a principal reduction for a standard loan if property values fall, or repayment if the borrower’s financial circumstances change. Better still, a loan with a re-draw facility or offset account, means that funds are always available to buy property bargains.

Steer clear of loan products with review clauses, and overdraft / revolving credit facilities such as overdrafts where the loan can be repayable on demand. These are high risk loans, especially in recessions when loans are difficult to refinance if repayment is demanded.

Irresponsible Lending? – case studies

Karamihos – the loan was $1.2m at 80% LVR to refinance an existing home loan and for investment purposes. The borrowers were over 70 years of age. Their exit strategy was to repay the 25 year loan from sale of their business premises. The lender should have checked that the value of the business premises was as the borrowers had said to see if their exit strategy was viable. In the end it did not matter and a possession order was made. [decision of the NSW Court of Appeal 14/02/2015]
Fink – the loan was more than $3m, a mixture of home loans and business loans. The borrowers were antique dealers, who needed funds to complete the construction of a traditional French Château on Wallis Island, near Forster (of all places!). The court rejected the borrowers’ argument that despite their payment defaults, it was unjust for the lender to demand repayment before the building was completed. The Court said: To lend money on unremarkable commercial terms for the completion of a partially constructed dwelling, even if its style and location give it the character of a folly rather than an investment, is not unjust. The loans were fully recoverable. [decision of the NSW Supreme Court 5/05/2015]

Château “Le Marais”
1 Wallis Island, Forster

ASIC Regulatory Guide 209 - Examples

Non-disclosed loans – A borrower’s bank statements might reveal loan repayments on a non-disclosed loan. If so, the lender needs to make additional enquiries, such as whether the loan is still current, and if so, how many more payments there are to be made. [Example 4]
Expenses – A lender may use a benchmark living expenses figure as a guide, but needs to look at actual living expenses figures (as per bank and credit card statements) in assessing a loan application. If the living expenses need to be reduced to qualify for the loan, the borrower must agree to a budget to reduce them. [Example 7]
Balloon repayments – While a borrower may have no difficulty in managing regular repayments under a loan, if a final large payment (a “balloon payment”) is required, the lender must be satisfied that the borrower understands and has the capacity to make that final payment. [Example 15]
Buy, renovate and sell – Loans with substantial upfront costs such as LMI and establishment fees are not suitable where the borrower is looking to sell in the near future because of the costs, unless the lender has explored other alternatives first. [Example 16]

Are NINJAs responsible for tougher loan requirements?

A NINJA loan (No Income No Job (and) no Assets) is a term used in the United States mortgage industry to describe subprime loans made to people with difficult to verify incomes, such as restaurant employees. The practice was widespread during the US housing bubble of 2003 to 2007.

In many cases, NINJA loans were given to people who could never repay them – and who like Ninjas, disappeared. They were a significant factor in the subprime lending crisis, and a cause of the GFC in 2008.

We can thank the NINJAs for the Responsible Lending Guidelines.

Click to Find out more about:

The Fink Case – Fink’s Folly
There is (almost) no consumer protection for business loans

Credit files and credit reporting agencies – Why missing a credit card payment makes it harder to qualify for a property loan

Who we recommend as mortgage brokers / finance brokers

Property Loan Alert for Interest-only loans - Why interest-only loans are being restricted in Australia