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Breaking down the new 'responsible lending' practices

SME Finance Group explains the changes being implemented across the Australian banking sector, affecting all business-related borrowing

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26 April 2017

The Australian banking sector is currently undergoing an enormous change which will affect all business-related borrowings. The Australian Prudential Regulation Authority (APRA) - the banking regulator - is determined to have more control over banks' lending practices than any time in the past. So what is happening to the market with the following?

· Residential mortgage lending for investment purposes
· Loan-to-value ratio (LVR) – the loan percentage you borrow
· Interest-only (IO) loans for your home mortgage
· Interest-only loans
· Commercial and industrial property mortgages
· The loan approval process - How do the banks manage loan serviceability?

Interest-only loans have been a traditional offering for many decades in Australia, especially for residential investment.

In future, banks will penalise the borrower by as much as 0.35 per cent or 35 points - it has already started. Going forward the interest-only home mortgage loan of old will be more difficult to apply for: APRA wants more principal-and-interest (P&I)loans and to reduce the high numbers of interest-only loans.

Loan-to-value ratios will be a deciding factor in the future; be it your home, or a residential investment mortgage, or a commercial and industrial mortgage.
The lenders' approval conditions will be more strict on home loans with LVRs greater than 80 per cent, and loans over 60 per cent LVR in the commercial and industrial space.

The new era of banking is upon us, get used to it. The majority of new loans are now controlled by a box-ticking exercise application.

If the loan assessor is unable to tick a box on the application; the loan process will stop until the box is ticked. This will not change as the new horizon in the banking world is upon us: the banks do not want any of their staff making credit decisions if the box cannot be ticked. Our newspapers, TV and radio, and the web are talking about the booming property market being overheated. The residential investment loan market is getting tougher due to banks' lending practices.

Take for example a customer who applies for an IO bank loan, at say today's interest rate (4.5 per cent). A bank's internal approval calculator increases the interest rate to 7.5 per cent and then does the loan calculations over, say, 25 years principal and interest. This is how it looks with their numbers versus the customer's application:
· An IO loan of $750,000 at 4.5 per cent interest will be $2,812.50 per month
· A principal and interest (P&I) loan of $750,000 at 4.5 per cent interest over 25 years will be $5508 per calendar month
· As witnessed with these repayments a bank's approval calculator virtually doubles the customer's annual commitment; the calculator takes into account the interest rate increases and the original principal which needs to be repaid. The process is known as 'responsible lending'.

So the customers apply for a loan assuming 4.5 per cent interest only - $33,500 per year ($2812.5 x 12) whereas a bank's internal systems tell them it is $66,000 per year taking in to account interest rate increases and principle payment.

A customer's disposable income will then be assessed for approval purposes on the higher rate with P&I, even though the mortgage contract is at 4.5 per cent IO. This method is starting to affect many customers' home loan affordability.

If customers are seeking a property investment, maybe start to look at commercial property; higher returns range from 5.5 – 8 per cent.

Interest rates will be higher offset by the higher income as a tenant would pay all outgoings and normal maintenance.

Interest rates are at the bottom of the cycle and we will probably see increases over the next 12 months, in which case it may be time to look at fixing your rate.

SME Finance Group have a no-obligation service which provides you with a health check on your current mortgage to make sure your bank is delivering you the best possible interest rate.

Please feel free to contact the SMEFG office to speak about your current mortgage or one you may be considering via email at sme@smefg.com.au or call 1300 ASK SME (1300 275 763).

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