Meeting the Requirements for

Interest Only Loans

Brad Lynch

Lawyer

1. Report 445 – Review of Interest only home loans -Released August 2015

2. Report 493 – Review of Interest-only home loans: Mortgage Brokers Inquiries into consumers requirements and objectives – Released September 2016.

Useful ASIC Guidance on Interest Only Home Loans

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ASIC expect that credit licensees would make many, if not all, of the inquiries in RG 209.33, as entering into an unsuitable home loan can have a potentially large negative financial impact on a consumer. – Report 445

Scalability Home Loans (Interest Only and P&I)

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Pros

• Flexible repayments

• Redirect cash flow

• Temporary finance

• Tax Benefits

Cons

• Not building equity

• Higher overall interest cost

• Larger repayments when move to P&I.

Why have an interest only home loan?

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Finding 1:

Lack of evidence of inquiries into requirements and objectives

Not keep sufficient evidence of inquiries into consumer’s requirements and objectives and not always clear how an interest-only home loan meets the requirements of an owner-occupier.

Report 445 Review of Interest only home loans

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Action 1:

Make and document inquiries into a consumer’s requirements and objectives. For interest-only home loans, consider whether specific features, benefits and costs associated with the loan meet the consumer’s objectives.

Action 2:

Ensure that the period of interest-only repayments aligns with the particular consumer’s requirements and objectives.

Be very careful if over 5 Year IO period (particularly Owner Occupier)

Report 445 Review of Interest only home loans

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Finding 2:

Affordability and interest-only home loans

Not ensure sufficient surplus income above their expenses and loan repayments to withstand income/ expense fluctuations or an interest rate rise.

Some lenders didn’t apply buffer to existing debts

Report 445 Review of Interest only home loans

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Action 3

Ensure adequate policies and processes are in place to assess a consumer’s ability to meet their financial obligations, including the effect of future interest rate rises on the proposed credit contract and existing credit contracts.

Report 445Review of Interest only home loans

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Finding 3:

Variation in treatment of volatile and irregular income

Higher income figure being used for serviceability assessments where there was a substantial difference between previous years’ incomes.

Rental income discounted by 20% to allow for property expenses and periods of non-occupancy where the property-related expenses would likely be greater than 20% of rental income.

Report 445Review of Interest only home loans

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Action 4

• Review policies for assessing volatile or irregular income sources to ensure they meet the responsible lending

• Appropriately discount or disregard high or volatile income

• For rental income, ensure the level of discounting is sufficient to allow for property expenses and periods of non-occupancy;

• If using a negative gearing benefit in serviceability calculations, ensure it takes into account that individual consumer’s circumstances

Record what you have done

Report 445 Review of Interest only home loans

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Finding 4:

Lack of evidence of inquiries into expenses and reliance on benchmarks

Not demonstrate sufficient inquiries into a consumer’s expenses and relied heavily on expense benchmarks to estimate living expenses.

Expense benchmarks are not a replacement for proper inquiries into a consumer’s actual expenses.

Report 445 Review of Interest only home loans

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Action 5

Make reasonable inquiries into a consumer’s actual expenses, take reasonable steps to verify the information obtained and document what you have done.

Action 6

Use income-adjusted benchmarks (reflecting the reality that higher-income consumers generally have higher living expenses).

If a consumer’s actual living expenses are higher than the benchmark, don’t use the lower benchmark figure in the serviceability calculation unless can explain why.

Action 7

Verify the amount of existing debt and the repayment amounts.

Action 8

Identify inconsistencies in information provided by consumers and make further inquiries. The outcome of any additional steps taken should be documented.

Report 445 Review of Interest only home loans

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Finding 5:

Capacity to pay after interest-only period not based on residual-term payments

Some lenders calculated affordability using repayments that are artificially low, as they were based on principal-and-interest repayments being made over the full term of the loan, rather than the residual term remaining after the interest-only period.

Report 445 Review of Interest only home loans

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Action 9

Lenders should assess a consumer’s capacity to make the principal-and-interest repayments over the residual term of the loan (after the interest-only period lapses), as this will better reflect a consumer’s ability to meet their financial obligations under an interest-only home loan.

Report 445 Review of Interest only home loans

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Finding 6:

Lack of flexibility for hardship variations for interest-only home loans

Some lenders applied more restrictive options for borrowers seeking hardship variations under an interest-only home loan.

Report 445Review of Interest only home loans

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Action 10

Lenders should:

• review their systems, policies and processes for hardship variations for interest-only home loans;

• have a variety of options available to consumers who are in financial hardship; and

• assess the most appropriate outcome of a hardship application on a case-by-case basis.

Report 445 Review of Interest only home loans

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Table 1: Responsible lending key findings and actions

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Table 1: Responsible lending key findings and actions (continued)

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For me the key messages are:

• Make sure your staff are properly trained so they understand, can explain and apply the pros and cons of interest only home loans

• Have very clear processes and procedures for interest only home loans and make sure they are carefully followed

• Document, Document, Document! – make sure you have a proper record of the customer’s requirements and objectives and why the interest only loan proposed (including the term) meets them

• Make sure you assess capacity over the residual P&I term

Key Interest only Home Loan take home messages

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