In a parallel announcement, ASIC will conduct a surveillance into the provision of interest-only loans as part of a broader review by regulators into home-lending standards. The probe will look at the conduct of banks, including the big four, and non-bank lenders and how they are complying with important consumer protection laws, including their responsible lending obligations. The review follows concerns by regulators about higher-risk lending, following strong house price growth in Sydney and Melbourne.
Through the Council of Financial Regulators, ASIC, APRA, the Reserve Bank of Australia (RBA) and the Treasury are working together to monitor, assess and respond to risks in the housing market. Interest-only loans as a percentage of new housing loan approvals by banks reached a new high of 42.5% in the September 2014 quarter (this includes owner-occupied and housing investment loans). ASIC Deputy Chairman Peter Kell said, ‘While house prices have been experiencing growth in many parts of Australia, it remains critical that lenders are not putting consumers into unsuitable loans that could see them end up with unsustainable levels of debt. ‘Compliance with responsible lending laws is a key focus for ASIC. If our review identifies lenders’ conduct has fallen short, we will take appropriate enforcement action.’
Background
The Australian Prudential Regulation Authority (APRA) announced today it has written to all authorised deposit-taking institutions (ADIs) to set out plans for a heightened level of supervisory oversight on mortgage lending in the period ahead. See the earlier DFA post in relation to this.
With interest-only loans, a borrower’s repayment amount will only cover the interest on the loan. The principal amount borrowed will not reduce unless the borrower chooses to make extra repayments. Paying interest-only means that a borrower will pay more interest over the term of the loan. Some borrowers choose interest-only loans to maximise the amount they can borrow, especially if it is for investment purposes. Loans are usually only interest-only for a set period of time, after which the borrower will either need to increase their repayments to start reducing the principal, or repay the loan in full.
Although interest-only loans can be appropriate in the right circumstances, interest-only loans can raise a number of risks, such as:
- Whether the borrower can only afford a loan because it is interest-only
- Whether the borrower can afford principal and interest repayments at the end of the interest-only period, and
- Whether the borrower understands the impact of not making principal and interest repayments.
The responsible lending obligations require credit licensees to ensure that consumers are only placed in credit contracts that meet their requirements and objectives and that they can meet their repayment obligations without substantial hardship. In doing this, credit licensees must make reasonable inquiries into an individual consumer’s specific circumstances and take reasonable steps to verify the consumer’s financial situation.
In August 2014, the Federal Court handed down its first decision on the responsible lending obligations: ASIC v The Cash Store (in liquidation) [2014]. The Federal Court’s decision made it clear credit licensees must, at a minimum, inquire about the consumer’s current income and living expenses to comply with the responsible lending obligations. Further inquiries may be needed depending on the circumstances of the particular consumer.
In response, in November 2014 ASIC updated Regulatory Guide 209 Credit licensing: Responsible lending conduct to incorporate the general findings of the Federal Court on the responsible lending obligations for credit licensees. ASIC also updated RG 209 to make it clear that credit licensees cannot rely solely on benchmark living expense figures rather than taking separate steps to inquire into borrowers’ actual living expenses.
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