Unfair loans face ‘perfect storm’

The royal commission into banking and financial services is being urged to investigate systemic irresponsible lending.

APRA chairman Wayne Byres. Picture: Hollie Adams

The royal commission into banking and financial services is being urged to investigate systemic irresponsible lending in the $1.7 trillion mortgage market, as victims flood law firms with claims they’ve been saddled with unpayable debts.

Josh Mennen, superannuation and insurance principal at Mau­rice Blackburn, said his law firm had seen a dramatic increase in the number of borrowers complaining about unfair credit contracts.

Under responsible lending laws introduced in 2010, banks and mortgage brokers must not make loans to customers who will not be able to repay them. Lenders must also adequately test whether customers can meet repayments, and must avoid providing loans that are unsuitable for borrowers.

“Despite those protections, we’re seeing that for the past decade, bank mortgage lending has been free and loose — particularly with interest-only loans,” Mr Mennen told The Australian.

Interest-only loans have recently been the subject of intense regulatory attention, with the Australian Prudential Regulation Authority last March telling banks to limit this type of lending to 30 per cent of new borrowers.

Monthly repayments on interest-only loans — which do not require payment of the loan principal for about five years — jump by about 50 per cent at the end of the interest-only period.

An explosive report from UBS analyst Jonathan Mott concluded that a third of borrowers with an interest-only loan don’t realise they are not paying back any of the loan’s principal.

It is believed that many borrowers entered into interest-only mortgages not long before APRA began to force banks to lift lending standards in late 2014. The bulk of these loans are expected to mature in 2020, which worries analysts because many of these borrowers may not be able to repay the loans.

“We’re finding that that five-year period is expiring for many people now,” Mr Mennen said.

“It’s still early days, because we’re just starting to see the damage. Previously, we used to see unfair credit inquiries around once a month. It then became once a week and now it’s at a rate of one a day,” he said.

“A lot of people are going to be pushed into hardship at the same time house prices are slumping. Meanwhile, interest rates are only going one way.

“It feels like we’re at the start of this perfect storm of consumer claims against the banks and brokers for overextending them. While there’s been negligence and breaches in the past, there haven’t been the losses on property — which is why we haven’t seen this area of the law develop.

“When house prices were rising, even the most naive mum-and-dad investors could still make a capital gain if they needed to liquidate to pay out their mortgage.”

Mr Mennen said Kenneth Hayne’s royal commission into banking and financial services should investigate the sector‘s track record with responsible lending laws.

“This is happening now — all the other industry problems, which were outrageous and caused a lot of damage, have been dealt with to varying extents. This is unfolding at the moment. This will see a lot of spilt blood over coming years and I think Hayne will be interested in this area,” he said.

The Australian Securities & Investments Commission has ramped up its surveillance of lending standards in the industry in recent months, examining whether banks properly took into account borrowers’ ability to make repayments at the end of the interest-only period.

Westpac, Australia’s second-largest bank, was recently taken to court by ASIC for allegedly breaching responsible-lending laws when providing interest-only mortgages. Westpac has denied the claims.

APRA boss Wayne Byres recently said the regulator was focusing on how lenders assessed living expenses and total indebtedness, after it found banks were far too reliant on living expense benchmarks. A common benchmark is the University of Melbourne’s Household Expend­iture Measure, which APRA has criticised for being simplistic.

Mr Mennen also said the royal commission should investigate the reinsurance sector.

Last week The Australian revealed QBE, Insurance Australia Group, Suncorp, Allianz, Zurich, Westpac Insurance, Comm­Insure, and OnePath were among insurers that received letters from Mr Hayne asking them to air a decade of dirty laundry to kick off the year-long inquiry into misconduct in the financial sector. Reinsurer Munich Re did not receive a letter, while it is unclear whether Swiss Re has been included in the sweep.

“The reinsurers have gotten off the hook in all the controversy in the life insurance scandals,” Mr Mennen said.

“The amount of downward pressure the reinsurers put on a life insurer is extraordinary. Often they are one of the reasons behind a claim denial. But they don’t suffer any reputational damage — they don’t have a retail operation to protect.”