Expert Advice with Simon Buckingham
On September 25th, Federal Treasurer Josh Frydenberg announced sweeping changes were coming to remove overly restrictive "responsible lending" rules, in order to make borrowing easier and more efficient.
The Treasurer stated in his announcement that "the principles which underpin responsible lending obligations have been implemented in a way that is no longer fit for purpose and which risks slowing our economic recovery."
As a result, the National Consumer Credit Protection Act will be overhauled, with new more flexible lending rules to be implemented from March 1st, 2021.
Why the change?
According to the Treasurer, the objectives of the change include:
- Simplifying Australia's credit framework to ensure consumers and small businesses can get timely access to credit as the economy recovers following the coronavirus crisis;
- Enabling a more efficient flow of credit to consumers and small businesses while maintaining strong consumer protections, through a suite of changes to Australian credit laws;
- Improving the flow of credit to support business investment and create jobs.
Treasury and the Reserve Bank of Australia have come to the conclusion that the current rules around lending have led to banks putting in place overly detailed and time-consuming credit approval processes under a "one-size-fits-all" approach.
As many investors and home buyers can attest, in recent times getting a loan has become extremely burdensome - often with significant delays (and uncertainties) in obtaining approval.
Even the RBA Governor has recently observed that what began as responsible lending principles has translated into "the undesirable consequence of unduly restricting lending".
What is changing, and how will it affect you?
By March 1st, the Government intends to "simplify the law through changes to the Credit Act to reduce the time and cost of credit assessments for consumers and businesses, reduce red tape for consumers seeking a credit product, improve competition by making it easier for consumers to switch lenders, and enhance access to credit for small businesses."
A key change is that lenders will be allowed to rely on the information provided by borrowers, such as declarations of living expenses, unless there are reasonable grounds to suspect it is unreliable.
This removes the requirement for lenders to painstakingly attempt to verify certain details declared by a borrower, such as their budgeted living expenses.
As the Treasurer puts it, borrowers will be made more accountable for providing accurate information to inform lending decisions, replacing the current practice of "lender beware" with a "borrower responsibility" principle.
Why this is so important…
If you've been following my Expert Advice posts, you'll know that I've been advocating for this change since 2018 - when I first highlighted the "unintended consequences" on competition and the broader economy that were already emerging from the overly-zealous application of certain responsible lending principles.
Pressure from the financial regulators, along with the uncomfortable spotlight of the Financial Services Royal Commission, led most banks to require substantially more supporting documentation for loan applications and to increase their scrutiny of living expenses and existing debts.
This increased scrutiny on a borrower's living expenses by the big banks has meant more paperwork and prolonged delays in processing loan applications, thanks to a lot more manual handling in the application process.
Some banks took this to the extreme. For instance, Westpac started requiring loan applicants to provide a specific, itemised and evidenced break-down of their living expenses across 12 categories!
Many banks have also been asking borrowers to provide 3-6 months' worth of bank statements and credit card statements, which the bank then almost forensically examines to cross-check back against what was declared as expenses on the application.
"No kebab for you!"
Under this rigid "one-size-fits-all" approach, many lenders failed to differentiate between "fixed" versus "discretionary" living expenses when evaluating how much a home buyer or investor could reasonably afford to borrow.
This led to bizarre and well-documented instances where loan applicants were put through the wringer, or even had their applications denied, simply because a daily kebab lunch, or a Lite 'n' Easy diet, or a gym membership wasn't included in their declared living expenses!
Fixed vs. Discretionary Expenses
I've argued repeatedly that examining a potential borrower's expenses should be all about the recurring expenditure that a consumer is actually committed to, NOT the "discretionary" expenses that they can easily give up.
Anyone with real-world experience in owning property knows that you can and will sacrifice discretionary spending items in your budget in order to more easily afford the repayments on a home loan.
Magazine subscriptions, gym memberships, Foxtel, Netflix, and even takeaways and dining out are all costs that can be eliminated from a person's budget at a moment's notice.
(Just like they can be added to a person's budget at a moment's notice if the person feels they can afford them.)
So why should they have any relevance to the assessment of your loan application?
The failure of lenders to differentiate between "fixed" and "discretionary" expenses has unnecessarily inhibited the flow of credit in Australia, making it more difficult for home buyers, investors and small business owners to borrow - without any demonstrable benefits to financial stability or consumer protection.
The famous "wagyu & shiraz" case
This all came to a head last year when financial regulator ASIC took Westpac to court in a high profile case now known as the "wagyu and shiraz" case.
The regulator attempted to claim that Westpac had breached responsible lending laws by using a generic "Household Expenditure Measure" (HEM) to estimate borrowers' living expenses in numerous loan applications.
Westpac argued that responsible lending laws did not require banks to use a simplistic formula of "income minus declared expenses" when assessing a customer's ability to repay a loan.
In dismissing the court case, Justice Perram supported the important distinction between fixed and discretionary expenses, stating:
"…the mere fact that there are living expenses is not necessarily relevant to whether a consumer will be unable to comply with their loan obligations, because it is always possible that some of the living expenses might be forgone by the consumer in order to meet the repayments."
In fact, Justice Perram went further to really ram the point home - with such quotable quotes as:
"I may eat wagyu beef every day washed down with the finest shiraz… but, if I really want my new home, I can make do on much more modest fare."
"The fact that the consumer spends $100 per month on caviar throws no light on whether a given loan will put the consumer into circumstances of substantial hardship."
ASIC toyed with the idea of appealing the case, but has now confirmed that it will accept the decision. Case closed!
Common sense wins out - finally!
It may have taken two years and a pandemic-triggered recession for common sense to prevail, but it seems like change is finally here and will become entrenched in law before March next year.
In particular, the assessment of living expenses has been called out in the coming changes, with Treasury making it clear that lenders are expected to move away from obtaining and verifying extensive information about a borrower's expenses, in order to simplify and speed-up lending processes.
Farewell (and "good-riddance") to those onerous living expense assessments!
By allowing lenders to rely more on the declarations provided by borrowers, new loans and refinancing applications should be able to be processed faster, with more borrowers qualifying for more lending.
A HUGE change
This represents potentially the most significant relaxation in lending since 2010, with the exception of abolishing the 7% minimum interest rate test for loan applications in June last year.
That change (abolishing the 7% minimum interest rate test used when assessing a borrower's ability to afford a loan) had an immediate and very noticeable impact on the property market.
Combined with cuts to interest rates at the time, the change to loan servicing tests enabled more potential property buyers to access finance, triggering renewed activity in the property market.
The decline in property values witnessed leading into last year's Federal Election was reversed, and property prices rose in many parts of the country.
In fact, values were still rising off the back of those changes when the COVID-19 pandemic hit.
How will the new relaxation in lending impact the property market?
COVID-19 caused the property market to stall and fall back in much of the country.
However, an important driver of demand for property - and property values - is the ease (or otherwise) of access to credit.
We saw the impact of this in the second half of 2019, when values in much of the country rose as overly-restrictive servicing requirements were appropriately relaxed.
Back in May 2019, when we saw the changes coming, we went on record calling the bottom of the market,and forecast property values would begin to rise strongly.
Our forecasts were proven to be correct, with aggregate Australian property values subsequently rising by more than 10%, before COVID hit.
It stands to reason that as requirements relating to expense assessments and other "responsible lending" rules are relaxed (making it easier for more consumers and small business owners to borrow), we're likely to see a similar impact on the property market next year.
Good for the property market. Good for the economy.
Rising property values are also a driver of positive business & consumer sentiment, and of economic growth.
In recent times the RBA and the Government have recognised the relationship between home values, and economic prosperity.
It should come as no surprise that when people feel wealthier because the value of their home is rising, they're far more willing to spend and invest.
The window of opportunity is open once again…
The telegraphed relaxation in lending in March next year provides sophisticated property investors with one of the clearest signals yet of an impending resurgence in the property market.
The question you need to be asking yourself right now is this...
How will you position yourself to capitalise on the rebound, as lending restrictions ease and sentiment improves?
- Simon Buckingham
P.S. For the latest market insights and practical strategies, tips and techniques for investing successfully in today's changing property market, make sure you check out our upcoming free webinars and property workshops.
Simon Buckingham is Director of Results Mentoring and a highly experienced investor. Simon has been investing in property for over 15 years using a broad range of strategies including positive cash flow, renovations, property development and commercial properties, both within Australia and overseas.
Holding university degrees in Commerce and Law, and with over 10 years' experience as a business consultant, Simon turned his back on corporate life forever following the births of his two children and now spends his time investing, developing property, supporting multiple charities, and building businesses - while teaching others how they can do the same. He has personally coached hundreds of investors in techniques that can be used to profit from property in any market conditions, regularly facilitates public workshops and provides other free resources for property investors through ResultsMentoring.com, and has presented to thousands of people at property conferences and seminars around Australia and New Zealand.
Simon writes the highly regarded Sophisticated Property Investor e-newsletter and his opinions on the property market and real-world investing strategies have featured in Your Investment Property magazine, Smart Property Investment, Channel7 News at 6, Kevin Turner's Real Estate Talk, and Property Observer. He is co-author of the critically acclaimed property book The Real Deal: Property Invest Your Way to Financial Freedom, and a founding Mentor in Australia's award-winning personal mentoring service for property investors: the RESULTS Mentoring Program.
Disclaimer: while due care is taken, the viewpoints expressed by contributors do not necessarily reflect the opinions of Your Investment Property.