What is responsible lending?
Gone are the days when lenders would use a “one size fits all” approach in their assessment of a customer’s borrowing capacity. Likewise, formal loan approvals issued in a matter of days are now very rare.
With added scrutiny of responsible lending practices over the last year from the Royal Commission, the Australian Prudential Regulation Authority (APRA) and the Australian Securities & Investments Commission (ASIC), lenders are now enforcing stricter credit assessments.
Where previously a generic affordability index based on what is considered average living expenses was used for every loan application, lenders are now delving further into borrowers’ actual spending habits.
Greater disclosure of a borrower’s financial commitments and lifestyle expenses is now required on each loan application. It may also include a review of transaction accounts to see if the monthly debits “on average” match what is being declared on the loan application as living expenses. Lenders may also request to actually sight bills such as council and utility rates, school fees etc.
Some lenders have also introduced a debt vs income ratio whereby they monitor or investigate applications more closely where applicants’ total debts, including the proposed loan exceed their combined income by more than 4.5 times.
As an example, a loan application would be escalated for review in the following situation where the debt ($800k) to income ($150k) ratio has been calculated at 5.3 times:
Total existing and proposed borrowings for a household: $800,000
- existing mortgage: $300k
- new investment loan: $450K
- credit card limits: $20K
- car loan: $30K
Household income: $150,000
- Salary 1: $60K
- Salary 2: $70K
- Proposed gross rental property income of: $20K
For many, these new responsible lending guidelines may seem like an inconvenient probe which prolongs the application process.
However banks (and government bodies) would argue that truly understanding a borrower’s current and future financial circumstances is necessary to determine the right product and loan structure proposed to their clients, and more importantly define their true borrowing capacity.
Helpful hints to navigate the new lending climate
- Avoid surprises and obtain pre-approval from a lender prior to purchase so that loan serviceability is assessed prior to executing a purchase contract or attending an auction.
- Where possible, stipulate a 3+ week finance clause on a private treaty contract. Longer is generally better.
- Negotiate or make available longer settlement terms on contracts where possible (whether you are buying or selling) to give lenders adequate time to assess and approve applications.
- Have your supporting loan application documents ready as soon as possible in the process. These may include:
– 3-6 months of loan statements for all debts
– current financial year tax returns
– current payslips and any salary sacrifice statements
– tax payments to be paid to date (clear your tax debts in the ATO’s portal)
- Know and be true to your current living expenses and disclose them on the application form. People generally do not change their spending habits.
- Constantly engage with your broker, bank or accountant.
While the credit landscape is cautionary, the lending process doesn’t need to be daunting. Being well informed and getting the right advice means you’ll in the best position to establish and maintain appropriate lending terms. If you’d like to arrange a no-obligation chat with one of our lending specialists, click here to book an initial consultation.
* The information contained in this site is general and is not intended to serve as advice. DPM Financial Services Group recommends you obtain advice concerning specific matters before making a decision.