Trail commissions may lead to “poor customer outcomes,” – CBA

A senior manager of the Commonwealth Bank (CBA) has admitted that upfront and trailing commissions for mortgage brokers can lead to poor customer outcomes, as reported in the Australian Broker.

During his 15 March testimony before the Royal Commission, executive general manager of home buying Daniel Huggins said the commission structure is linked to the size of the loan. The longer loan takes to pay off, the larger the trailing commission will be. “[T]hat can lead to a conflict – well, there is a conflict between – between the customer, you know, and – and the broker,” he added.

Huggins confirmed to Senior Counsel Assisting Rowena Orr that brokers can maximise their income by getting the largest possible loan approved to extend over the longest period of time for the customer to repay.

The bank knew about this as early as February 2017, according to a confidential letter by outgoing CBA CEO Ian Narev to Stephen Sedgwick, who was the independent reviewer for the Retail Banking Remuneration Review back then. Orr presented the confidential letter during the hearing.

“We agree with the reviewer’s observations that while brokers provide a service that many potential mortgagees value, the use of loan size linked with upfront and trailing commissions for third parties can potentially lead to poor customer outcomes,” said Narev in the letter.

“We would support elevated controls and measures on incentives relates to mortgages that are consistent with their importance and the nature of the guidance that is provided,” Narev added. These initiatives include delinking of incentives from the value of the loan across the industry, and the potential extension of regulations such as future and financial advice to mortgages in retail banking.

Another CBA submission attached to Narev’s letter said that broker loans are reliably associated with higher leverage compared to those applied through proprietary channels. “[E]ven for customers with an identical estimate of ex ante risk, loans through the broker channel have higher leverage… [and] loans written through the broker channel have a higher incidents of interest only repayments,” it added.

Huggins agreed with Orr that CBA’s submission lends some support to the case for discontinuing the practice of volume-based commissions for third parties. But he said there are a range of considerations that the bank would have to make.

“There is a first mover problem, in that the person who moved first would likely lose a lot of volume. The second problem is you create a conflict if one person, or half of the people move, and the other half don’t,” Huggins said.

According to Huggins, CBA has not stopped paying volume based commissions to brokers. He also confirmed the lender has not taken any steps towards ceasing its practice.

More Digital Disruption Hits The Mortgage Industry

Another new player has entered the contested mortgage origination sector. Just launched is Loanbid  which says it empowers borrowers with access, choice, and competition to secure a loan from one website.

Using an auction model, borrowers enter their details and requirements once. Lenders and brokers can then assess the information and enter a virtual auction to win the loan with their one time best bids. The platform currently has 18 lenders on its panel, including many of the usual suspects.

All offers are shown to applicants via dashboard and are ranked according to the total cost of the loan. Email alerts are also part of the process. The applicant is not committed to taking a loan, and Loanbid does not offer any advice.

The platform does not charge customers an upfront fee or take trail commissions from lenders. If the loan is settled, Loanbid receives a referral fee from the successful lender or broker. So they are essentially “clipping the ticket.”

Borrowers are only identified by a reference number, so remain anonymous throughout the process. Loan proposals are independently and individually assessed without any impact on their credit rating.  Normal loan verification is then undertaken by the successful lender or broker.

Via Australian Broker

“Borrowers need to wait for just 48 hours for the lenders and brokers to come back to them with a loan best suited to their needs and financial situation, with the borrower to choose the right loan,” said Loanbid partner Paul Dwyer, formerly a banker at St George.

“We will put the power of choice back in the hands of borrowers, who can potentially access thousands of loans based on the information they provide through an obligation-free bidding process,” said Dwyer.

“We have been fastidious in deciding on our partners on the platform, to give our borrowers the best opportunity to ensure they get the right loan for their requirements and lifestyle,” said former NAB banker Darren Roach, a partner at Loanbid.


New Wave Of Cheap Interest Only Loans Hits

The story so far. Banks were lending up to 40%+ of mortgages with interest only loans, some even more.

The regulator eventually put a 30% cap on these loans and the volume has fallen well below the limit. Some banks almost stopped writing IO loans.

Source: APRA

They also repriced their IO book by up to 100 basis points, so creating a windfall profit. This is subject to an ACCC investigation to report soon.

The RBA and APRA both warn of the higher risks on IO loans, especially on investment properties, in a down turn.

APRA has confirmed the “temporary” 30% cap will stay for now, although the 10% growth cap in investment loans is now redundant, thanks to better underwriting standards.

Banks have now started to ramp up their selling of new IO loans, to customers who fit within current underwriting standards and are offering significant discounts.  Borrowers will be encouraged to churn to this lower rate.

This from Your Mortgage.

CBA will cut fixed interest rates for property investors across one-, two-, three-, and four-year terms. The cuts, which range from 0.05 percentage points to 0.5 percentage points, apply to both interest-only investor loans and principal-and-interest investor loans.

CBA is also cutting some of its fixed rates for owner-occupiers, including a reduction on owner-occupied principal-and-interest fixed-rate loans by 0.1% over terms of one to two years, landing at 3.89% for borrowers on package deals.

Key rival Westpac also unveiled a suite of fixed-rate changes on Friday, including some cuts to fixed-rate interest-only mortgages, another area where banks have been forced to apply the brakes. The Sydney-based bank also hiked rates across various fixed terms for owner-occupiers.

Westpac will increase fixed-rate owner-occupied home-loan interest rates by 0.1 percentage points for loans of one-, two-, four-, and five-year terms. Across three-year terms, the bank will leave rates unchanged at 4.19%.

Both banks’ rate changes will only impact customers who are taking out new fixed-rate loans, leaving existing mortgages untouched.

CBA’s aggressive pursuit of property investors comes after it said in its most recent half-year results that its loan book was growing more slowly than allowed by the regulators. Credit growth has slowed across the board and house prices in Sydney and Melbourne have begun to soften.

And this from the AFR:

Major lenders are expected to follow the Commonwealth Bank of Australia’s latest round of interest-only mortgage cuts after losing market share because of massively over-estimating the impact of lending caps on their loan books, despite regulatory fears about rising debt and prices, according to analysts.

“Expect others to follow,” said Steve Mickenbecker, group executive for financial services at Canstar, which monitors rates and charges for financial service products, about the CBA’s recent cuts.

Big four lenders started losing market share to smaller lenders and regulation-lite non-bank financial institutions when they slammed on the brakes to meet Australian Prudential Regulation Authority’s 30 per cent cap on interest-only loans.

CBA’s CEO-elect, Matt Comyn, recently flagged plans to rebuild interest-only market share after over-shooting the regulatory 30 per cent target and ending in the low 20s.

Well under lending caps

The bank’s mortgage growth in the 12 months to December 31 was about 5 per cent, compared with about 6 per cent system growth and more than 11 per cent for non-bank financial institutions (NBFI).

From Mortgage Professional Australia.

Meanwhile, Westpac-owned St George cut its two-year fixed-rate investment property loan marginally by -0.04% to 4.60%, and Aussie Home Loans cut its one-year fixed IQ Basic Investment Loan by -0.25% to 4.24%.

Other smaller lenders, such as ING, Mortgage House, and Virgin Money have also dropped some interest-only rates over the previous month.

… the story continues….

Mortgage Lending Sags In January

The latest APRA Monthly Banking Statistics to January 2018 tells an interesting tale. Total loans from ADI’s rose by $6.1 billion in the month, up 0.4%.  Within that loans for owner occupation rose 0.57%, up $5.96 billion to $1.05 trillion, while loans for investment purposes rose 0.04% or $210 million. 34.4% of loans in the portfolio are for investment purposes. So the rotation away from investment loans continues, and overall lending momentum is slowing a little  (but still represents an annual growth rate of nearly 5%, still well above inflation or income at 1.9%!)

Our trend tracker shows the movements quite well. (August 2017 contained a large adjustment.

Looking at the lender portfolio, we see some significant divergence in strategy.  Westpac is still driving investment loans the hardest, while CBA and ANZ portfolios have falling in total value, with lower new acquisitions and switching. Bank of Queensland and Macquarie are also lifting investment lending.

The market shares are not moving that much overall, with CBA still the largest OO lender, and Westpac the largest Investor lender.

Looking at investor portfolio movements for the past year, again significant variations with some smaller players still above the 10% speed limit, but the majors all well below (and some in negative territory).

We will report on the RBA data later on, which gives us an overall market view.

AFG 1H18 Results up 11%

Australian Finance Group (AFG) has today released half yearly results for 2018 with underlying NPAT in H1 FY2018 of $14.4m, up 11% on H1 FY2017, and a reported NPAT in H1 FY2018 of $16.7m.

Residential settlements were up 6% to $18.6b (interesting compared with Mortgage Choice’s 6% fall!) and their combined residential and commercial loan book is $140.8 billion with growth of 11% over H1 FY2017.

Settlements were strongest in NSW, then VIC. But growth in VIC was significantly stronger and it may overtake NSW ahead.  AFG Home Loans (AFGHL) continued to deliver positive financial growth and settlements grew 31% to $1.62 billion.  Lodgements were up 7%, servicing more than 17,000 customers.

The AFGHL loan book has reached $6.5 billion, an increase of 40% on the same period last year. AFGHL now represents 8.7% of overall AFG Residential settlements – up from 7.8% in FY17

Strong organic growth and cash flow generation of the business has allowed AFG to pay a Special Dividend of 12 cents per share.

AFG Securities completed a successful $350m Residential Mortgage Backed Securities (RMBS) issue in October 2017, which underlined the performance of the AFG Securities business.

AFG’s commercial business experienced loan book growth in all states despite softer settlements.

The overall commercial loan book grew by 14% to $7.2 billion. This growth has been driven by a 6% increase in sub-$5m commercial mortgage settlements and a 26% increase in asset finance.

Settlements slipped in NSW, but grew in VIC.

AFG Business has a current panel of five core lenders aimed at the small to medium enterprise (SME) market. Further business lending lines will be added as the platform is rolled out to more brokers looking to diversify their offering.

AFG had over 2,900 active brokers at 31 December 2017, further extending AFG’s national distribution network providing quality lending solutions and service to consumers. Growth continues to be strong in NSW and Victoria, offset by weaker conditions in other states.

The return on equity was 33% and they announced an interim dividend of 4.7c per share fully franked plus a special dividend of 12c per share fully franked

Did You Know How Big The IO Mortgage Book Is?

OK, so there has been lots of noise about the Mortgage Interest Only Exposures the banks have, and both APRA and the RBA say they are potentially risky, compared with Principal and Interest Loans. We already showed that conservatively $60 billion of IO loans will fail current underwriting standards.   That is more than 10% of the portfolio.

But how many loans are interest only, and what is the value of these loans? A good question, and one which is not straightforward to answer, as the monthly stats from the RBA and ABS do not split out IO loans. They should.

The only public source is from APRA’s Quarterly Property Exposures, the next edition to December 2017 comes out in mid March, hardly timely. So we have to revert to the September 2017 data which came out in December. This data is all ADI’s with greater than $1 billion of term loans, and does not include the non-bank sector which is not reported anywhere!

They reported that 26.9% of all loans, by number of loans were IO loans, down from a peak of 29.8% in September 2015. They also reported the value of these loans were 35.4% of all loans outstanding, down from a peak of 39.5% in September 2015.

So, what does this trend look like. Well the first chart shows the value of loans in Sept 2017 was $549 billion, down from a peak of $587 billion in March 2017. The number of loans outstanding was 1.56 million loans, down from a peak of 1.69 million loans in December 2016.

If we plot the trends by number of loans and value of loans, we see that the value exposed is still very high.

Finally, the average loan size for IO loans is significantly higher at $347,000 compared with $264,300 for all loans. Despite the fall in volume the average loan size is not falling (so far).

The point is the regulatory intervention is having a SMALL effect, and there is a large back book of loans written, so the problem is risky lending has not gone away.


Turning The Screws On Mortgage Lending – The Property Imperative Weekly 17th Feb 2018

Listen, You Can Hear the Screws Tightening On Mortgage Lending.  Welcome to The Property Imperative Weekly to 17th February 2018.

Watch the video, or read the transcript.

In this week’s digest of finance and property news we start with Governor Lowe’s statement to the House of Representatives Standing Committee on Economics.  He continued the themes, of better global economic news, lifting business investment and stronger employment on one hand; but weak wage growth, and high household debt on the other. But for me one comment really stood out. He said:

it would be a good outcome if we now experienced a run of years in which the rate of growth of housing costs and debt did not outstrip growth in our incomes in the way that they did over the past five years.

This is highly significant, given the fact the lending for housing is still growing faster than wages, at around three times, and home prices are continuing to drift a little lower. So don’t expect any moves from the Reserve Bank to ease lending conditions, or expect a boost in home prices. More evidence that the property market is indeed in transition. The era of strong capital appreciation is over for now.

There was lots of news this week about the mortgage industry. ANZ and Westpac have tightened serviceability requirements.  Westpac recently introduced strict tests of residential property borrowers’ current and future capacities to repay their loans. The change is said to be intended to identify scenarios that might affect borrowers’ capacity to pay back their loans. These scenarios include having dependents with special needs that might require borrowers to spend on long-term care and treatment. ANZ has added “a higher level of approval for some discretions” used in its home loan policy for assessing serviceability, reducing approvals outside normal terms.

Talking of lending standards, APRA released an important consultation paper on capital ratios. This may sound a dry subject, but the implications for the mortgage industry and the property market are potentially significant.  As part of the discussion paper, APRA, says that addressing the systemic concentration of ADI portfolios in residential mortgages is an important element of the proposals. They have FINALLY woken up to the risks in the system, just years too late!  We have significant numbers of loans in the system currently that would now not pass muster. More about that next week.

Their proposals, which focus in on mortgage serviceability, would change the industry significantly, as lower risk loans will be more highly prized (so expect low rate offers for lower LVRs), whilst investment loans, and interest only loans are likely to cost more and be harder to find. Combined this could certainly move the market!  The proposals introduce “standard” and “non-standard” risk categories.

As well as increasing the risk weights for some mortgages, they also continue to close the gap between the advanced (IRB) internal approach used by large lenders, and the standard approach used by smaller players. Those in transition (e.g. Bendigo Bank) may find less of an advantage in moving to advanced as a result. You can watch our separate video on this important topic.

Whilst the overall capital ratios will not change much, there is a significant rebalancing of metrics, and Banks will more investment and interest only loans will be most impacted.  So getting an investment loan will be somewhat harder and this will impact the property market. The proposals are for consultation, with a closing data 18 May 2018.

Another data point on the property market came from a new report by Knight Frank which claims that in 2017, one-third of Australian residential development sites were sold to Chinese investors and developers. The share of sales to Chinese buyers has tripled since 2013, but decreased from the 38 per cent recorded in 2016. The level of Chinese investment in residential development sites varied from state to state: in Victoria, 38.7 per cent of residential site sales were to Chinese buyers; in New South Wales, 35.6 per cent of residential site sales were to Chinese buyers, and in Queensland, Chinese buyers comprised 7.4 per cent of total residential site sale volumes. So this is one factor still supporting the market, though in Australia, the Australian Prudential Regulatory Authority has encouraged local financial institutions to impose stricter controls, while in China the government has attempted to moderate capital outflow with China’s Central Bank imposing new rules for companies which make yuan-denominated loans to overseas entities.

The data from the ABS on Lending Finance, the last part of the finance stats for December, really underscores the slowing momentum in investment property lending, especially in Sydney (though it is still a significant slug of new finance, and there is no justification to ease the current regulatory requirements.) The ABS says the total value of owner occupied housing commitments excluding alterations and additions rose 0.1% in trend terms, total personal finance commitments fell 0.2%. Revolving credit commitments fell 1.4%, while fixed lending commitments rose 0.5%. There was a small rise in lending for housing construction, but overall mortgage momentum looks like it is still slowing and the mix of commercial lending is tilting away from investment lending and towards other commercial purposes at 64%, which is a good thing.

There is an air of desperation from the construction sector, as sales momentum continues to ease, this despite slightly higher auction clearance rates last week. CoreLogic said the final auction clearance rate was 63.7 per cent clearance rate across almost double the volume of auctions week-on-week (1,470). Over the week prior, a clearance rate of 62.0 per cent was recorded across 790 auctions. Both auction clearance rate and volumes were lower than what was seen one year ago, when a 73.2 per cent clearance was recorded across 1,591 auctions. There is significant discounting going on at the moment to shift property, and some builders are looking to lend direct to purchases to make a sale. For example, Catapult Property Group launched a new lending division that will help first home buyers get home loans with a deposit of only $5,000. The Brisbane-based company encourages first home buyers in Queensland to enter the real estate market now by taking advantage of the state government’s $20,000 grant that is ending on 30 June 2018. This is at a time when lenders are insisting on larger deposits, and are applying more conservative underwriting standards.

Economic data out this week showed that according to the ABS, trend unemployment remained steady at 5.5%, where it has hovered for the past seven months.  The trend unemployment rate has fallen by 0.3 percentage points over the year but has been at approximately the same level for the past seven months, after the December 2017 figure was revised upward to 5.5 per cent. The ABS says that full-time employment grew by a further 9,000 persons in January, while part-time employment increased by 14,000 persons, underpinning a total increase in employment of 23,000 persons. The fact is that while more jobs are being created, it is not pulling the rate lower, and many of these jobs are lower paid part time roles – especially in in the healthcare sector. In fact, the growth in employment is strong for women than men.  A rather different story from the current political spin!

In a Banking Crisis, are Bank Deposits Safe? We discussed the consequences of recently introduced enhanced powers for APRA to deal with a bank in distress this week. There were several well publicised Government bail-out’s of banks which got into problems after the GFC. For example, the UK’s Royal Bank of Scotland was nationalised. This costs tax payers dear, so there were measures put in place to try to manage a more orderly transition when a bank gets into difficulty and raises the question of “Bail-in” arrangements.  Take New Zealand for example. There regulators have specific powers to grab savings held in the banks in assist in an orderly transition in the case of a failure, alongside capital and other bank assets.  And, given the New Zealand position (and the tight relationship between banking regulators in Australia and New Zealand), we should look at the position in Australia.  Are deposit funds in Australia likely to be “bailed-in”? Well, the Treasury confirmed that because deposits are not classified as capital instruments, and do not include terms that allow for their conversion or write-off, they cannot be ‘bailed-in’. But we have a catch all clause in APRA’s powers that says they can grab “any other instrument” and deposits, despite the Treasury reassuring words, is not explicitly excluded. So I for one cannot be 100% convinced savings will never be bailed-in. And that’s a worry! I recall the Productivity Commission comment last week, that financial stability had taken prime place compared with competition (and so customer value) in financial services. The issue of bail-in of deposits appears to be shaping the same way. You can watch our separate video discussion on this important topic.

The first round of public hearings for the Banking Royal Commission will focus on lending, including mortgages, credit cards and car loans; we heard during the opening session. The Commission highlighted the large size of the lending market, and the significant number of submissions they have already received on misconduct in this area, including relating to intermediaries, commission and advice. In addition, as part of the opening address, we were told that some of the major players were unable to provide the full range of misconduct information that Commission requested. Some players offered a few case studies, and were then asked to provide more detail over the past 5 years (as opposed to 10) but said they could not meet the required deadline. Based on the opening round, Banks are going to find this a painful process. Not least because The Commission is publishing information on the sector. In its first release, it pointed to declining competition in the banking sector, with the number of credit unions falling due to consolidation and the major banks holding 75 per cent of total assets held by ADIs in Australia. The paper noted that five of the 20 listed companies that make up the ASX20 are banks, noting that the major banks have “generally achieved higher profit margins than other types of ADIs” with a profit margin of 36.4 per cent in the June quarter 2017. They also underscored that Australia’s major banks are “comparatively more profitable” than some of their international peers in Canada, Sweden, Switzerland and the UK.

We expect to hear more from the Royal Commissions on unfair and predatory practices. To underscore this there was some good news for Credit Card holders, with new legalisation passed in parliament to force Credit card providers to scrap unfair and predatory practices. However, the implementation timetable is extended into 2019. The reforms include:

Requiring affordability assessments be based on a consumer’s ability to repay the credit limit within a reasonable period (from July 2018).  This tightens responsible lending obligations for credit card contracts.

Banning unsolicited offers of credit limit increases (from January 2019). At the moment, whilst the law forbids providers from making these sorts of offers in writing, offers can be made by phone and other mediums. This loophole has been exploited, but will now be closed.

Simplifying how credit card interest is calculated, especially, banning the practice of backdating interest rate charges. Currently, some providers were attracting new customers with promotional low rate, or no rate offers, say for the first month. But, if a customer failed to pay off in full a credit card bill after the first month, the credit card company was often retrospectively applying the new interest rate to previous purchases. This was allowed in the banks’ small print, but the government said the practice did “not align with consumers’ understanding and expectation about how interest is to be charged”. This will be banned, from next year.

Requiring credit card providers to have online options to cancel cards or to reduce credit limits (from January 2019). At the moment, some card providers force customers to come into a bank branch to reduce limits or terminate cards, and when they did come in were often persuaded not to do it. The asymmetry between fast credit card approvals online, and slow cancellation will end.

So another week highlighting the stresses and strains in the banking sector, and the forces behind slowing momentum in the property market. And based on the stance of the regulators, we think the screws will get tighter in the months ahead, putting more downward pressure on mortgage lending home prices and the Banking Sector. Something which the RBA says is a good thing!

Home Lending Accelerates In December

The latest data from APRA, the monthly banking stats for ADI’s shows a growth in total home loan balances to $1.6 trillion, up 0.5%. Within that, lending for owner occupation rose 0.59% from last month to $1.047 trillion while investment loans rose 0.32% to $553 billion. 34.56% of the portfolio are for investment purposes.

The monthly ADI trends show this clearly (the blip in August was CBA adjustments). Growth accelerated across all loans, and within each type.

The portfolio movements within institutions show that Westpac is taking the lions share of investment loans (we suggest this involves significant refinancing of existing loans), CBA investment balances fell, while most other players were chasing owner occupied loans. Note the AMP Bank, which looks like a reclassification exercise.

Overall market shares remain stable, with CBA holding the largest share of owner occupied loans and Westpac leading on investment loans.

The 10% speed limit for investment loans is less interesting, given the 12 month average grow of 2.4%, but most of the majors are well below the 10%. Westpac is the major growing its investment book fastest, while CBA is in reverse. Clearly different strategies are in play.

Standing back, the momentum in lending is surprisingly strong, and reinforces the need to continue to tighten lending standards. This does not gel with recent home price falls, so something is going to give. Either we will see home prices start to lift, or mortgage momentum will sag. Either way, we are clearly in uncertain territory. Given the CoreLogic mortgage leading indicator stats were down, we suspect lending momentum will slide, following lower home prices. We publish our Household Finance Confidence Index shortly where we get an updated read on household intentions.

The RBA data comes out shortly, and we will see what adjustments they report, and momentum in the non-bank sector.

To Buy, Or Not To Buy, That IS indeed the Question

We get a steady flow of questions from those who read our research, or follow our posts, but one question, more than any other we get asked is –  Should I Buy Property Now? Many cite the real estate industry claims that now is a great time to buy – but is it really? Today we are going to explore this question, but with a caveat. This is NOT financial advice, and is simply my opinion, based our own research and surveys. Your mileage may vary. The market is different across states and locations.

Watch the video or read the transcript.

But it is an important question given that home prices appear to have reached something of a peak, and may be sliding in some areas; housing is Australia is unaffordable, as the recent Demographia report showed; banks are tightening their lending standards under regulatory pressure; net rental streams are looking pretty stressed; many households are under severe financial pressure, and mortgage interest rates are likely to rise.

In fact, we have a generation of home buyers and prospective home buyers who have only ever seen home values rise, and if you are in the property owning system, is has become a significant source of wealth creation, amplified if you are a property investor, and assisted by ultra-low interest rates, tax breaks and other incentives.  But will the good times continue to roll? Not necessarily.

So to decide if now is a good time to buy, consider these questions.

First, why do you want to buy a property? Up until recently, our surveys have shown the number one reason to buy was capital appreciation and wealth building, with finding somewhere to live a poor second. But now, if you are wanting to buy to grow wealth, we say be careful, as the market dynamics are changing, and its likely prices will slide. Also there may be changes to negative gearing under a Labor government, and property investment mortgage rates are likely to rise, while rental streams are not, so more investment properties, on a cash flow basis will be under water. At the moment there are much better returns from the buoyant stock market, though of course that may change. Remember that prices crashed by 40% in Ireland, 35% in the USA and 25% in UK after the GFC. Prices can go down as well as up. Property is not a one-way bet!

But, if you are seeking to buy, for somewhere to live, and capital growth is less important to you, then it may still be a good time to transact. Prices are already down, and many sellers are accepting deeper discounts off the asking price to make a deal. In addition, if you are a first time buyer, there are state incentives and really low mortgage rates available. But remember you are still buying into a highly unaffordable market, and the capital value of your property may fall. This could turn into a paper loss, and indeed should you need to sell, a real financial hit. The way a mortgage works is you put in a deposit, and the bank lends the rest. But in a falling market, it is your deposit which is eroded. After the GFC many households in the northern hemisphere ended up in negative equity, meaning the value of their mortgage was larger than the market value of their property. As a result, people were stuck living in their properties unable to move, hoping the market would rise again. In fact, it did over the next 10 years, so now many are no longer in negative equity. But it can be a long and winding road.

Next, if you do decide to buy, do the work. First look around at property available, and recent sales, to get a sense of the market. Also look in different areas, and even different states. Often locations a little further from public transport are cheaper – but then is the trade-off worth it? Also compare new builds with existing property. Often newly constructed homes carry a premium, which just like a new car, on first use falls away. On the other hand, there are some desperate builders out there, with big projects, and few buyers, especially in the high-rise belts of Brisbane, Melbourne and Sydney, so they may do a deal. We are seeing a steady stream of people who sign up for off the plan builds, but then when it comes to getting a mortgage, they cannot find one, so cannot complete. So read the small print on these contracts. Ask yourself, what happens if you cannot complete the transaction.

It is also harder to add any value to a new property, whereas an older one may offer more potential for investment and upgrade, and this can be a way of helping to preserve value. There is an old adage – buy the worst property on the best street. This is still true, with caveats – you should check the condition of the property so you know what you are up for.

Also, do the work when it comes to a mortgage. Our research shows you can often get better mortgage rates from some of the smaller customer owned lender, as opposed to the big four by going direct to them. So shop around. Whilst using a broker may help, again we find that some of the best rates are found by borrowers who do the work themselves. Many brokers will do the right thing, and really help, but there is a risk that the commission and ownership structure of broker firms may mean they do not have access to the best rates, and they may not always be working in your best interests, so be careful.

There is more work to do also, on affordability. A lender will make an offer of a mortgage, based on your financial details as contained in the application, and supporting evidence. Remember lenders want to make a loan – it is the only game in town in terms of their profitability – but there is evidence that some lenders will offer a bigger loan, by using more aggressive living expenses, and income assumptions. That said, the industry is getting more conservative, with lower allowable loan to value ratios, and some income categories now reduced.

Just because the lender says you can have a loan, does not mean you should get the loan. The lender is looking at risk of loss from their perspective, not yours. If you have a large deposit, then the bank can assume that capital is available on default to recover their mortgage. Remember in Australia, you cannot just walk away and return the keys, the liability stays with you. So, ask the lender, not just about repayments at current interest rates, but also what happens if they rise. A good rule of thumb is catering for a 3% rise in rates. Get the lender to tell you what the revised repayments would be at this higher rate, and ask yourself if you could still make the repayments. This is important, as incomes are not growing in real terms and mortgage rates may well rise. If you cannot make the repayments at 3% high, get a smaller loan, and buy a smaller place.

You may need to build your own cash flow to test what is affordable – again do not rely on the bank for this – remember they are concerned about risk of loss to their shareholders, not to you.  ASIC’s MoneySmart Budget Planner is a good starting point. Also, remember to include the transaction and stamp duty costs in your calculations.

Another area is the deposit you will need. These days you are likely to need a bigger deposit. 20% would be a good target, as this then avoids having to pay for expensive Lenders Mortgage Insurance. Above that, you will need this facility – which to be clear, protects the bank, not you!

More prospective borrowers are turning to the Bank of Mum and Dad, for help, but there are also risks attached to this arrangement – see our earlier Video Blog on the Bank of Mum and Dad. Some buyers are clubbing together to purchase, but there are risks attached to these arrangements too.

Finally, if you do buy, work on the assumption you will need to hold the property for some time – say a minimum of 3-5 years. The old trick of flicking after a year or so will not work if, as we expect prices fall. Remember too that there are additional costs to owning a property from council rates, running costs – such as electricity – and maintenance costs. Owning property is an expensive business.   Make sure these costs are included in your cash flows.

So what’s the bottom line?  If you are wanting to buy to put shelter over your family’s head, and can afford the mortgage, and are willing to accept a risk of loss of capital, then do the work, and it might be the right thing to do.  A capital gain is by no means certain in the current climate!

But, if you are looking at property as a wealth building tool, I think you might do better to hold off, as prices are likely to slide, and the costs of an investment mortgage are on the rise. At very least look in areas around Hobart and Adelaide where value is better at the moment.

In fact, though, the only reason I can see to transact in this case is to lock in a negative gearing arrangement now, before the next Federal election. But then, that seems to me to be a long bow, and our modelling suggests that the removal of negative gearing will have only a minor impact on the market. There are a bunch of other more compelling reasons to think the market will fall.

So in summary, whatever type of borrower you are, do the work and be very careful. Prices may rise, but they can also certainly fall, and a mortgage could just be a noose around your neck.

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APRA Mortgage Curbs Permanent?

Calls to reduce the current regulatory restrictions, for example on investor and interest only loans, will probably fall on deaf ears. Last year, the Bank of England confirmed that its own version of APRA lending curbs will become a “structural feature” of the British housing market, forcing Australian economists to begin questioning whether APRA’s macro-prudential measures could be permanent. This from the excellent James Mitchell via The Adviser.

A leading mortgage professional has criticised the prudential regulator for not providing a clear time frame for its macro-prudential measures or explaining what it is ultimately looking to achieve.

Speaking to The Adviser on a recent Elite Broker podcast, Intuitive Finance managing director Andrew Mirams said that he can’t see the complexities in the mortgage market easing up “anytime soon”.

Australian banks are still required to limit their investor mortgage growth to 10 per cent, while interest-only loans can only account for 30 per cent of new lending.

“Late last year, [APRA chairman] Wayne Byres came out and said these are all temporary measures,” Mr Mirams said. “But he’s never articulated to anyone about how temporary or what measures might change in the future or what their actual outcome.

“I think a lot of the things they’ve done, they’ve got right. An investor getting a 97 per cent interest-only loan just didn’t make sense. You’re just putting people at risk should the markets move, and we all know markets move at different times.

“But they haven’t articulated what they were trying to achieve, what sort of timeline and what outcomes they are hoping to get. I think that would help all of us manage client expectations. Because all of us will have lots of clients that are getting frustrated with being told ‘no’. And you can’t really give them an outcome of what or when they might be able to move again.”

In October last year, Mr Byres spoke at the Customer Owned Banking Convention in Brisbane, where he indicated that the regulator would like to start scaling back its intervention, provided that banks can continue to lend responsibly.

“We would ideally like to start to step back from the degree of intervention we are exercising today,” Mr Byres said.

“Quantitative benchmarks, such as that on investor lending growth, have served a useful purpose but were always intended as temporary measures. That remains our intent, but for those of you who chafe at the constraint, their removal will require us to be comfortable that the industry’s serviceability standards have been sufficiently improved and — crucially — will be sustained.”

Macro-prudential measures are a relatively new instrument but have becoming increasingly popular across the globe. In addition to Australia, lending curbs are also being used in the UK, New Zealand and Hong Kong.

Last year, the Bank of England confirmed that its own version of APRA lending curbs will become a “structural feature” of the British housing market, forcing Australian economists to begin questioning whether APRA’s macro-prudential measures could be permanent.

AMP Capital chief economist Shane Oliver believes that APRA’s measures, or at least some of them, will become permanent.

“I suspect that, as time goes by, they will likely become a permanent feature because of the control over risky behaviour that they allow over and above that achieved by varying interest rates and because the regulatory framework necessary to administer them will become more entrenched,” Mr Oliver said.

Mr Oliver believes that APRA’s mortgage curbs may be seen as increasingly attractive from a social policy perspective, in that they can “tilt lending away from non-first home owner-occupiers”.

There are other reasons why APRA’s measures are likely to remain.

“Poor affordability and high household debt levels, neither of which are likely to go away quickly,” Mr Oliver said.