17th April 2008
Is Low/No Doc Lending Responsible?
It is always interesting to see how consumer protection groups, regulators and the press, wrestle with the idea that mortgage products, like all services, evolve over time but some innovations when made by lenders - to assist genuinely needy or marginalised borrowers - may have the appearance of entreating borrowers to take up loans that they cannot otherwise afford just because of the associated marketing or the ease with which all lenders now seem to make finance available.
All of us have had, at some time, our bank or financial institution write to us, or our partner, offering to increase our credit card limit - and have done so without our request or any apparent checking of our capacity to manage the higher limit or repay same; this has been going on for decades.
Mortgages however are treated with a higher reverence by all concerned and we felt that in the current over-crowded market and the now broad adoption by Australian lenders and brokers of more US style mortgage product innovations - such as reverse mortgages, high loan-to-valuation loans, and now NO Doc loans, it is important to outline why we at La Trobe believe that our Lite Doc lending program, remains sound and responsible lending.
Full Doc, Low Doc or No Doc!
The main point of differentiation of any Low Doc loan program is that the borrower applicant is not required to provide traditional methods of substantiation as to their income or capacity to repay the loan requested.
Traditionally a borrower would have been asked to provide a letter of income and employment, and/or copies of pay slips, or a completed and recent Taxation return. Low Doc loans waive this standard paper based verification methodology of proving a borrower's capacity to repay a loan; which was in turn used to calculate a simple ratio of the proposed loan repayments to borrower income - a commitment ratio - which was not to exceed a certain percentage of a borrower's income, (traditionally 30% joint applicants and 35% single applicants).
However Low Doc loans, if utilized correctly by a lender, should check the capacity of a borrower in different ways to maintain their ethical responsibility to the borrower to make a sound lending decision. Low Doc loans, when made prudently, ensure capacity of the borrower to repay the loan is verified by other means such as:
- An independent of borrower, sourced credit bureau report of borrower's past borrowings and history of repayments with other lenders;
- Borrower's declaration as to income ("stated income"/ self certification and taxation return lodgement status) which can be verified by calling the relevant employer by telephone when applicant is PAYG; and /or
- when self employed additionally an Accountant's declaration may be obtained as to repayment ability from relevant accountant who prepares taxation return of the applicant borrower, also confirming lodgement of most recently required tax returns;
- name search of the lender's own database records of borrower's previous dealings (La Trobe has a data base of over 93,000 individuals and previous history) to ensure no previous adverse record;
- requirement that all self employed applicants be registered for GST and hold an ABN, which means the borrower applicant earns more than $65,000 per annum;
- for refinance applications (REFI's), statements from the previous lender as to repayment history for up to last 12 months, ( La Trobe require 6 months statement for APRA regulated lenders (banks) and longer from unrecognised non bank lenders);
- full statement as to assets and liabilities, so the applicant's asset position is reviewed and an opinion is formed as to financial capacity with money generally given the age of the applicant (asset accumulation for age); and
- a reasonableness test applied to the application so that the loan amount should never be greater than 3-4 times the stated income.
Character testing of the borrower through employment and residential address stability, credit bureau reports confirm this.
La Trobe also use the following warning on all declarations made by low doc borrowers or their accountants: Warning: You are applying for finance and La Trobe is relying on the declarations that you have made above in making its credit decision. Please make sure that the declarations are correct. Obtaining finance by deception, fraud or dishonesty (which includes making false statements as to income) are crimes which may be punishable by imprisonment.
Interestingly the soundness of such loans was tested by the national banking regulator, APRA, in late 2003, which found that whilst the arrears rate (default ratio) of such loans was roughly 2 to 3 times higher than the Banks' equivalent Full Doc (Prime) loans, the loss severity ratio (actual losses sustained) on Low Doc loans was the same as a Full Doc loan; that is very little losses sustained in practice.
Because the APRA review was conducted soon after the Banks had commenced lending on a Low Doc basis APRA decided as a precaution to what they had perceived as an over heated lending market, changed the capital required to be held by a Bank to support such loans to a 100% risk weighting for loan >60% LVR that did not carry Lenders Mortgage Insurance ($8 for every $100 advanced) rather than the 50% normally applied ($4 for every $100 advanced). However in recognition of the infancy of such Bank lending and the early juncture of this imposition, the APRA in its September 16th release - AGN112.1 - decided further that such Low Doc loans are to be weighted 50% once the borrowers' ... have had substantially met the contractual loan repayments continuously over the last 36 months' (3 years).
Overstatement of Income
The Australian Taxation Office (ATO) also examined Low Doc loans on a limited sample basis since June 2004, against claims in the press of fraudulent over statement of income by applicants using Low Docs to borrow. According to the ATO's own press release, the ATO only examined 350 loans, although their review received wide press coverage as to the frauds occurring under low doc programs. They stated that the ATO found a high incidence of overstatement of income in the low doc applications or a failure to lodge tax returns.
Regrettably the ATO did not undertake a similar review of a test group of loans on a Full Doc basis and reference same to the taxation returns supplied by the Full Doc borrowers. One would expect that on a similar sample basis Full Doc loans would also exhibit some overstatement of income compared to the taxable income declared to the ATO by the borrowers; that is Low Docs do not in themselves exclusively cause misrepresentation of income by borrowers to lenders ... this has been going on since 'Adam was a boy'. Importantly the ATO recognise that borrowers of Low Doc loans are not using same for purposes of aggressive taxation planning.
La Trobe mitigates the potential for applicants to overstate income on our Lite Doc loans, by virtue of the requisite declarations by the borrower which certify that their current tax returns are up to date and they have lodged recent returns. La Trobe require the support of an additional Accountant's declaration for each Lite Doc loan, which confirms lodgement of tax returns and can been seen in the aforementioned 8 point credit assessment of all Lite Doc loans.
What happens to Low Doc lending under Anti-Money Laundering Laws
Under the recently introduced Anti-Money Laundering Laws, lenders must properly identify the low-doc customers which may be counterintuitive. As an example, the Federal Government is currently concerned about lost tax revenues from people who have not submitted tax returns but are applying for low-doc loans. The Australian Taxation Office (ATO) revealed that at least half of the low-documentation borrowers surveyed in late 2004 had not submitted a tax return for an average of three years. The ATO has accumulated AUS$23 million in taxation payable and penalties from an audit of 140 low-doc consumers. It was anticipated that the threat of a full-scale ATO investigation would curb incidents of tax avoidance. The investigation may however only prompt future regulatory compliance such as the requirement that all low-doc borrowers' Tax File Number (TFN) details are submitted to the ATO at time of loan application.
The greater threat to Low Doc lending is the requirement by the consumer lobby groups to state all loans made should only be made when a lender is able to demonstrate the borrower's proper capacity to repay the loan.
In today's day and age of speed dating, Internet shopping and paying bills online, it comes as no surprise that home loan approvals are also just a "click" away. "Low-doc" has become the preferred short form for low-documentation. Before low-doc loans existed, taking out a mortgage required hundreds of pages of documentation, especially if you were self-employed. These borrowers had to submit the last two or three years of company financials, the last two years of personal tax returns and often a letter from their accountant clarifying issues that arose.
Because of the required two year salary track record, many small business owners who chose to take out less salary in order to re-invest in their companies (and minimise income tax along the way) were getting squeezed out of the home loan market. The low-doc lending market has evolved over the past five years to fill this gap.
These days over 12% of Australians are self-employed, and according to online recruitment company SEEK, 82% of jobseekers are interested in owning their own business at some stage in their career. To address the needs of this growing group of potential borrowers, Australian lenders have made it easier for them by offering low-doc loans with different loan types, a range of tiers, and different leverage levels. Low-doc loans have also brought the benefit of home finance to other people who would previously have been excluded from the market such as recent immigrants, people with fluctuating income levels, and people who live off commissions or investments.
To read more about Low/No Doc lending from a mortgage insurers view, click HERE.
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Head of Lending
Iain Pepper is a Vice-President and the Head of Lending for the La Trobe Group.Read full profile here.
La Trobe is one of Australia's leading independent specialist mortgage Financiers. Its business includes residential mortgages, commercial mortgages, and investment services operating one of Australia's largest Mortgage Funds under AFSL 222213. It employs over 145 staff and has raised over AUD$10Billion to assist over 100,000 customers since inception in 1952.
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