The High Cost Of Easy Loans

Sydney Morning Herald

Wednesday February 11, 1998

PAUL COOMBES

Today it is easier than ever to get a loan to buy your home. Therefore, it is easier to get in over your head with mortgage borrowing, unless you are cautious.

Estimates in lending circles are that up to 10 per cent of home borrowers are in arrears in their loan repayments at any one time, and between 1 and 2 per cent are in default - hard-core delinquent loans.

Borrowers in arrears are generally defined as not having made full repayments within three months. After three months, if this situation continues, borrowers are moved to the default category.

The 10 per cent figure comes as a shock to many, and lenders act quickly to correct it to avoid loans dropping into the delinquent category.

There is no doubt problems are hitting below the mortgage belt. Part of this is blamed on a loosening of credit evaluations of borrowers because of the intense competition between banks and mortgage originators for market share.

The principal mortgage insurer, Housing Loans Insurance Corporation (HLIC), had a 19 per cent increase in claims last financial year to $36.4 million and expects the situation to worsen. [The $36.4 million covers the difference between the realised price of a home and the loan amount outstanding to the lender, so it is significant.] HLIC underwrites about half of the mortgage insurance market.

The Reserve Bank has been warning against a lowering of lending standards. This is a viewpoint supported by Professor Tom Valentine, the dean of commerce, University of Western Sydney, who was recently reported as telling a Federal Parliament seminar that "mortgage originators seemed to be becoming more lax in their credit evaluation procedure for new loans".

Paul Rowe, the secretary of the

Co-operative Housing Societies Association (CHSA), believes there is a great deal of ignorance among borrowers, and this obviously contributes to the problem. They are not prudent and do not look ahead to things that could happen to them. When borrowing, people need a margin to handle some change in their circumstances.

"Borrowers need to consider the

likelihood of family growth, any changes in employment that don't fit their expectations, unforeseen health problems and increasing health costs and insurance premiums, and the costs of actually getting into and establishing a home - particularly a new one where landscaping and fencing can be involved.

"In our conservative organisation, where we lend a maximum of $300,000, the percentage of problem loans has grown to 5 per cent at times, but I have heard of it being closer to 10 per cent in other organisations, although they don't publicly admit it," Rowe adds.

He confirms the beliefs of others that home loans are too easy to get and there has been a big downturn in criteria as competition has eroded the cautionary gates for lenders and borrowers.

Because of the barriers being down, it is easier for intending borrowers to disguise their real

situation by furnishing doctored tax returns, employment and contract documents and other records to lenders wanting the business.

Rowe continues: "When lending is getting easier, it is easier for people to over-commit and borrow more. Sometimes they "churn" loans,

swapping lenders and getting increased amounts on any increased value in the home, without fully having the capacity to service the new loan and pay statutory fees.

"Borrowers should be told the pitfalls of doing this. There is provision for these warnings in Section 7 of the NSW Home [Finance] Contracts Act and I see benefits of extending home borrowing practices to the Consumer Credit Code or creating a new section of the Trade Practices Act to help avoid arrears and defaults."

In addition, there is the code of the Home Purchases Assistance Authority to help with this, but the code is not available publicly, or to private lenders, because the authority "doesn't want to be misrepresented by the other lenders". [See panel - Prudent lending code.]

James Balfour, the Commonwealth Bank's credit manager in personal banking, says its lending standards have not changed since the advent of mortgage originators, but admits they have made market inroads.

There are many reasons for people falling into arrears and even default. These range from forgetting to make the deposit, receiving funds later than expected, to spouses separating and the loss of a job. Any of these things can cause a glitch.

Regardless of the reason, the bank strives to help its customers restore payments to the agreed schedule. It wants to avoid forced sales or even mortgagee sales when the borrower can frequently wind up with negative equity in the property.

When these difficult situations arise, the bank doesn't want to get customers upset, but how it proceeds depends in part on the customer's history, the arrears, the customer's equity in the home and then the degree of default.

Balfour says: "Any shortfall in a repayment would be arrears. We get these all the time. When a shortfall occurs, the customer is usually

contacted by phone, or a letter is written, but if there is no response or satisfactory arrangement, the loan falls to the default category after 90 days.

"Arrangements we can make with borrowers are for reduced repayments for a period to help them over their difficult period and increased

repayments after that time. Another way is reduced repayments, but an extension of the loan period to cover the shortfalls. In most cases we expect people to catch up their payments within a few weeks.

"We don't want the situation to drag on. If it does, the borrower can be under water and lose everything. Sometimes owners have to realise they can't meet repayments and sell the home sooner rather than later so they can salvage some of the equity still in it. But I emphasise, we are lenders, not financial advisers."

The bank's research reveals that more than 50 per cent of its borrowers are repaying more than agreed each month. There are many reasons for this, but it could partly be influenced by the tax incentive of reducing the mortgage and knowing you have the redraw facility for any emergency, as opposed to saving the money and

paying tax on the interest.

NEGATIVE EQUITY: Occurs when borrowings exceed the value of the property.

PRUDENT LENDING

The Home Purchases Assistance Authority offers a six-page document which suggests a lending and recovery procedure to help lenders and borrowers avoid grief.

* Step one is usually a letter outlining the situation. Follow-up letters are sent if the first one is ignored. A quick chat and implementation of agreed steps can often save the home.

* The agreements usually allow the borrower to progressively reduce the debt, without any undue hardship. It should be realistic, so the debt does not become unmanageable through compounding interest charges.

* Agreements should be confirmed in writing.

* Correcting an arrears situation usually takes about six months.

The Cooperative Housing Societies Association offers family counselling to help with decision making, but it is not compulsory.

© 1998 Sydney Morning Herald

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