Time to crack down on ‘lying loans’ to put out the house price bonfire
But if I do, despite my personal skin in the game, I will welcome whatever so-called “macro-prudential policies” – additional restrictions on borrowing – that regulators decide to take.
Because when you are standing near a raging fire, it is safe to try and put out the flames.
Of course, a really careful firefighter would also consider why the fire started in the first place. In this case, a combination of generous tax breaks, supply barriers and ultra-low interest rates created an inflammatory mix.
Still, stricter lending rules are better than nothing. And, as I discovered during my recent loan research, there is considerable leeway to tighten things up quickly, if we want to.
As most borrowers know, when you apply for a loan, the lender needs to assess your ability to “manage” it – that is, to cope with the principal repayments and ongoing interest charges required. .
Your ability to pay off a mortgage is crucially dependent on your monthly net income – the difference between your income and your monthly living expenses – and the cost of borrowing – that is, interest rates.
If the cost of borrowing goes down, as it does, you can afford to pay off a larger home loan out of a given monthly net income.
Of course, it’s also important that you can continue to repay the loan if interest rates rise.
Banks used to subject borrowers to “stress tests” to ensure that their income, net of living expenses, was large enough to cover the 7% interest expense. In 2019, this was relaxed to a “buffer” of at least 2.5% above the current loan rate. Today that usually means something a little over 5%. The Commonwealth Bank recently increased its stress test to 5.25 percent.
Basically, the higher this rate, the smaller the loan you get. Increasing this cushion is therefore one of the ways in which regulators could slow credit growth.
They can also, as New Zealand has done, simply put a cap on the proportion of a lender’s loan that can be taken out at high debt-to-income ratios – six or more. Many lenders are already activating additional checks on borrowers requesting high debt-to-income ratios. Such a cap could attract investors like me, but it could also stumble heavily indebted first-time homebuyers entering the market.
As for the bank’s assessment of a person’s net monthly income, I see considerable leeway for repression.
Right now, responsible lending laws only require banks to make “reasonable inquiries” into a person’s “financial situation” to ensure that the loan they are leaving with is ” not inappropriate ”. Mortgage brokers also have an obligation to ensure that the loans they make are in the “best interests” of clients.
But since Judge Nye Perram’s landmark legal ruling in the famous “Wagyu and Shiraz” case, it is less clear how many questions about the actual living costs of potential borrowers banks have to make.
As Perram reflected in his judgment, “I can eat Wagyu beef everyday washed down with the best shiraz, but, if I really want my new home, I can get by with a much lower price.”
Even before this decision, the living expense estimates provided in loan applications in Australia tended to cluster around a figure known as the “Household Expense Measure”, developed and regularly updated by the Melbourne. Institute, paid by subscription by banks and not made public.
It describes a modest level of living expenses that excludes private tuition fees, stratum fees, vacation abroad, and health insurance, for example. Mortgage lenders and brokers have been known to trick borrowers to give it – or something close – as an estimate of their living expenses to increase their borrowing potential.