A decade of soaring property growth, generous tax incentives for property investors and record low interest rates has resulted in Australians being among the most indebted households in the world.
A recent Australian Bureau of Statistics (ABS) report into household debt found that in 2015-16, 29% of households were classified as ‘over-indebted’, defined as having debt three times or more than disposable income, or debt equal to 75% or more of the value of assets. The average home loans for over-indebted households were over four times the size of home loans held by other households carrying debt ($286,400 compared to $59,500).
Many property investors have successfully managed their repayment obligations while riding the property wave. But the wave is due to crash soon, and it’s not going to be pretty.
Property growth can no longer be presumed, with the surging Sydney market beginning to plateau and even dip, while interest rates can only increase. Many would-be real estate entrepreneurs are starting to feel the strain of so much debt and distress sales are on the rise.
A combination of banks’ relaxed lending standards and brokers’ involvement in loan sales has resulted in widespread debt over-commitment that threatens the stability of the broader economy: A survey of more than 900 home loans conducted by investment bank UBS found that around $500 billion worth of outstanding home loans are based on incorrect statements about incomes, assets, existing debts and/or expenses. This means 18% of all outstanding Australian credit is based on inaccurate information, often caused by poor advice or misrepresentations by a mortgage broker eager to generate a sale commission. A staggering 30% of loans surveyed had been issued based on understated living costs and around 15% on understated other debts or overstated income.
Until recently, this problem has been contained, as investors who defaulted on their mortgages were often fortunate enough to sell the investment property at a gain or at least break even, clearing the mortgage without too much pain.
However if interest rates rise by 1%, more than 40% of homes would be in mortgage stress (for context, a 4% increase above current rates would bring interest rates roughly in line with the average over the past two decades). This will further drive up distress sales in a stagnant or contracting market and may leave thousands in financial ruin, staring at the prospect of bankruptcy.
Making matters worse, a large proportion of mortgage loans issued over the past decade were ‘interest-only loans’. These loans have an initial period, usually 5 years, where only the interest on the loan is repaid. However, after the interest-only period ends, the loan repayments can increase between 30-60% which can push the customer into mortgage stress.
A review of home loans with an interest-only period conducted by the Australian Securities and Investments Commission (ASIC) found that:
- in the March 2015 quarter, interest-only home lending had increased almost 20% from the previous year, and made up around 42% of all new home loans issued in that quarter;
- the average value of interest-only home loan amounts is substantially higher than that for principal-and-interest home loans for both owner-occupiers and investors. That’s because of the lower initial repayment figure under this type of loan and the effect of ‘present bias’ (where people focus on present costs and features over future costs and features);
- mortgage brokers may be incentivised to recommend an interest-only home loan, as the principal will not initially be paid down and the trail commission will be paid for a number of years on a higher balance.
It has also been reported that up to a third of borrowers with interest-only loans may not realise they have them.
The good news is that customers who fall into default may have a legal claim against their lender for compensation.
Following the Global Financial Crisis in July 2010 the National Consumer Credit Protection Act 2009 (National Credit Act) imposed responsible lending obligations on lenders that require them to assess whether a loan is unsuitable considering the customer’s requirements, objectives and financial situation.
A lender must not approve a mortgage with a consumer unless it has made an assessment about whether the contract will be unsuitable and made inquiries and verifications, including:
- make reasonable inquiries about the customer’s requirements and objectives in relation to the credit contract; and
- make reasonable inquiries about the customer’s financial situation; and,
- take reasonable steps to verify the customer’s financial situation; and
- make inquiries prescribed by the regulations about any matter prescribed by the regulations; and
- take any steps prescribed by the regulations to verify any matter prescribed by the regulations.
If a customer can only comply with the financial obligations under a loan contract by selling their principal place of residence, it is likely that that the loan will be considered unsuitable.
Lenders that give an unsuitable loan can be made to compensate the customer if loss is suffered as a result. However important time limits for making a claim apply and a consumer is likely to lose their right to make a claim if they become bankrupt. This is why it’s essential that consumers get advice early.
Warning signs that a loan may have been issued unlawfully
The following are warning signs that the lender may be in breach of responsible lending laws:
- The lender failed to make enquiries to ensure that the loan was suitable for the customer’s requirements or objectives
- The lender failed to verify the customer’s reliable income in your loan application, e.g. it included bonuses or overtime, or it failed to obtain PAYG records
- The lender did not ask the customer about their actual living expenses or obtain statements but instead determined their monthly expenses based on a benchmark tool like the Household Expenditure Measure
- The customer was suffering from illness, was elderly, or did not understand English when they applied for the loan
- The customer was given an interest-only loan that they are struggling to repay since the interest-only period ended or will struggle to pay at that time
- The customer’s interest-only loan had an interest-only period of greater than five years
- The customer’s home was used as security for a loan used to buy an investment property
- The loan was for more than the value of the investment property
- The lender did not ensure that the customer could still repay the loan if the interest rate increased
- The lender failed to properly consider the customer’s existing debts
- The lender over-estimated the rental income returns from an investment property that the customer was planning to buy with the loan
- The customer’s ability to repay the loan was reliant on rising house prices.
It can be difficult to obtain information from lenders about the process it followed to assess the loan suitability, and to determine whether the lender has breached its legal obligations.
Maurice Blackburn's financial advice lawyers are experts in the field and can help each step of the way to get compensation. We act ‘no win no fee’. Please call 1800 331 968.