ASIC today released a report that found lenders providing interest-only mortgages need to lift their standards to meet important consumer protection laws.
ASIC's probe into interest-only home loans was announced in December 2014 (refer: 14-329MR) and looked at 11 lenders, including the big four banks, to assess how they are complying with responsible lending laws.
As the national regulator for consumer credit and responsible lending, ASIC identified that demand for interest-only loans had grown by around 80% since 2012. ASIC's review looked at how consumers were assessed for loans by lenders with a focus on the affordability of the loans over the longer term.
The review found that interest-only loans are more popular with investors and those on higher incomes, and that delinquency rates are currently lower for interest-only home loans.
However, ASIC also found that lenders have been falling short of their responsible lending obligations in the provision of interest-only loans. Lenders are often failing to consider whether an interest-only loan will meet a consumer's needs, particularly in the medium to long-term.
ASIC’s review of more than 140 consumer loan files from bank and non-bank lenders identified:
- In 40% of files reviewed, the affordability calculations assumed the borrower had longer to repay the principal on the loan than they actually did
- In over 30% of files reviewed, there was no evidence that the lender had considered whether the interest-only loan met the borrower's requirements
- In over 20% of files reviewed, lenders had not considered the borrower’s actual living expenses when approving the loan, but relied instead on expenditure benchmarks.
These practices can expose borrowers to not being able to afford their loan repayments in the future, particularly for interest-only loans, which have much higher repayments after the initial interest-only period ends.
ASIC also issued a survey to the 11 lenders to gain valuable data about the growth of interest-only home loans. The findings are detailed in Report 445, Interest-only home loan review (REP 445).
ASIC Deputy Chair Peter Kell said, 'Interest-only loans may be a reasonable option for some borrowers. However, lenders must have robust processes in place for assessing a customer's ability to afford a loan, taking into account the increased repayments once the interest-only period ends. They should lend responsibly, and in a way that does not result in consumers taking on debt that they cannot afford, especially if interest rates rise.'
The report makes a number of recommendations that lenders and brokers should review to ensure they are complying with responsible lending obligations. Following ASIC's review, all 11 lenders have changed their practices in line with ASIC's recommendations or have committed to implementing necessary changes in the coming months. The recommendations include ensuring:
- loans align with consumers' requirements and objectives
- lenders use a consumers' actual expenses rather than relying on a benchmark
- affordability assessments include buffers for future interest rate rises.
Mr Kell said, 'We are pleased that the lenders involved in the review have already started implementing changes based on our findings. The rest of the lending industry, including brokers, should now take note and swiftly review the practices they have in place to ensure they comply with their responsible lending obligations.'
As a result of this review, ASIC has commenced follow-up investigations in certain cases which are ongoing. Where necessary, ASIC is considering enforcement action or other regulatory action.
Under the National Consumer Credit Protection Act 2009 (Cth), ASIC is the regulator for responsible lending. In light of the growth in interest-only loans, ASIC commenced a review of these loans in consultation and collaboration with other regulators. Through the Council of Financial Regulators, ASIC, APRA, the RBA and the Treasury are working together to monitor, assess and respond to risks in the housing market.
Based on a $500,000 principal and interest home loan over thirty years, a consumer would pay around $579,032 in interest with a constant interest rate of 6%. For an interest-only loan of the same amount, with the same interest rate consumers would pay the following:
Length of interest-only period
Interest payable over term of loan
Additional interest paid compared to principal-and-interest home loan
For those consumers, interest-only home loans can appear to be more affordable because their repayments are initially lower than principal and interest home loans. However, if incorrectly assessed, consumers may end up taking on a loan that they cannot afford to repay in the long term, particularly if interest rates rise.
ASIC has updated its guidance to consumers on ASIC's MoneySmart website in order to provide updated information about what to consider and the risks involved with interest-only loans.