- The 10 things lenders and brokers need to know about interest-only home loans
ASIC’s report 493 into interest-only home loans highlights the importance of responsible lending practices for both mortgage brokers and lenders, and how both can ensure consumers requirements and objectives are given due consideration.
The report also identifies good practices and contains valuable guidance for Authorised Deposit-Taking Institutions (ADIs) and mortgage brokers looking to improve the way they write interest-only home loan business.
Here we have distilled our top ten takeaways from the report for mortgage brokers and lenders so that you can get the process of writing interest-only home loan business right from start to finish.
- The clear number 1 - Focus on the consumer. Consumers have varying degrees of financial literacy and as the broker you must focus on understanding their circumstances, requirements and objectives over the life on the loan. You should also provide them with a summary statement for their review and formal confirmation. It is important to ensure that the consumer understands the product and its features, how it operates, and any potential risks. Remember, joint borrowers may have different requirements and objectives and any tension between these will need to be resolved for you, the broker, to provide a recommendation.
- Document, document, document! Documentation of how the interest-only feature meets the consumer’s requirements and objectives is essential to demonstrate that the loan was “not unsuitable” under the National Credit Act. The documentation needs to address the cost, repayments and equity features of the loan product and should all be in the one place. An inquiry tool can serve this purpose – see point three below. The broking house should retain this information in the event of the departure of the representative involved in writing the business.
- Tools are part of the solution. Tools such as a fact find or needs analysis do not of themselves satisfy the responsible lending requirements and normally a text narrative in the tool is required to document how the loan satisfies the consumer’s requirements and objectives. Tools that require all questions to be answered and all fields to be completed are preferable to ones that allow skipping. Where an answer is nil or n/a – an explanation of why this is the case would be best practice.
- Relying on other advisors is not enough. When an interest-only loan is recommended to a consumer by another advisor (such as an accountant), the broker or lender cannot simply rely on this recommendation; they must consider whether the interest-only loan meets the consumer’s requirements and objectives. For example, an accountant may recommend an interest-only loan for tax deductibility benefits, however the consumer may be placed into a product with a higher overall cash flow requirement that may not be in their best interests. It is incumbent on the broker and/or lender to assess the consumers objectives independently.
- Policy and procedures. Most brokers can improve on the depth of information and extent to which products or features of a loan are tailored to meet the needs of a consumer’s specific circumstances and objectives. Information should be provided to front line broking representatives on circumstances in which products and features may be unsuitable and what to do in these situations.
- Does the consumer understand what they have to do to benefit from the product? Where a consumer needs to take a specific action to benefit from the product, it is essential that the broker and/or lender ensures that they are clearly advised of what action they need to take, the time frames they need to act within, and the consequences of not taking the action.
- Large brokers will be held to a higher standard. Brokers who impact a larger number of consumers will be expected to adhere to higher standards, with regulators potentially having less tolerance for breaches of responsible lending in larger brokers than smaller brokers.
- Third party distribution channels require risk management consideration by ADI lenders. ADIs will need to demonstrate how they have addressed the risk of third party channels in their risk management framework. Issues to consider include compliance with responsible lending obligations and other compliance requirements, how ADIs have selected and accredited third parties, how they monitor performance, and how they take remediation actions as required including terminating brokers who do not meet acceptable performance standards.
- Underwriting audits are a must for lenders to demonstrate sound risk management frameworks. While brokers may retain considerable information in their tools and document management systems, lenders must demonstrate they conduct appropriate reviews of the business written by brokers, and that under a Three Lines of Defence risk management framework the first and second lines of defence are undertaking appropriate monitoring, review, and challenge functions. This is particularly important where a third party channel is a significant source of introduced business and/or this source has seen above system growth in recent years.
- Training of broker representatives is a must. Training helps to ensure standards are raised, consumers are protected, and lenders/brokers comply with responsible lending obligations.
How can Grant Thornton help?
For lenders and brokers looking to improve their processes, we can conduct responsible lending audits/reviews, financial statements audits, internal audits, CPS220 Comprehensive Reviews, ICAAP reviews, and provide advice regarding your governance, risk and compliance practices.