Why your credit rating is going to become a lot more important

Why your credit rating is going to become a lot more important

There has been a lot of media around the findings of the recent royal commission and how the banks have now made it significantly harder to apply for a loan. Another change, that was mandated prior to the royal commission, is set to place a much greater importance on keeping your credit file squeaky clean.

Most people who apply for a loan, from a mortgage to a credit card, accept that the lender will perform a credit check on them. Whilst these credit checks have always played a significant role in whether the application was accepted or declined the data that was historically available was limited to three items:

  1. The date of the last credit enquiry for the applicant.
  2. The name of the credit provider that made the inquiry, e.g. ANZ bank
  3. If there were any credit defaults or bankruptcy registered against the applicant. A credit default includes a repayment in arrears for a period of 60 days or more.

The lender would then rely on the applicant to include the balances and structure of any outstanding loans in their application and back them up with the relevant statements.

On 2 November 2017 the government announced it would legislate for a mandatory Comprehensive Credit Reporting (CCR) regime to come into effect by 1 July 2018. So by 1 October 2018 the four major banks were required to report that 50% of their credit data, including home loans, credit cards, car leases, etc. are shared with a credit bureau and made available to other industry participants. By 1 October 2019 this figure will grow to include 100% of all credit data.

Whilst the government’s mandate only applies to the four major banks, to gain access to the data a lender must also be a participant so it’s expected the smaller lenders will follow.

What does this mean?

Under the new reporting regime, the number of data points contained in a credit file would be significantly increased. In addition to the three listed above, the information available to lenders would include far more detail around the balance and limit of any loans you have outstanding or closed, the type and structure of those loans and their month by month payment history for the previous two years.

All these factors will then be considered to produce a credit score for the applicant of between 0 and 1000. Clearly this will provide lenders access to a lot more data, enabling them to better assess a borrower’s true credit position and hence their ability to repay a loan.

How will this affect me when applying for a loan?

As more Comprehensive Credit Reporting (CCR) information becomes available, it should drive competition and result in lenders offering a better deal based on your unique credit circumstances. In short you could be rewarded for a good credit score with a lower interest rate or punished for a bad one. The race will be on to best utilize this level of data and introduces the possibility of nimble fintech start-ups to enter the marketplace.

It may also result in a reduction in the documents you need to provide the lender with your application. If a lender can view your current balances and repayment history, then there may not be a need to provide this information in the form of paper statements.

Whichever way you look at it, the change will place far more importance on maintaining a clean credit file and will ultimately result in a more competitive risk adjusted lending market.

Getting a home loan is getting a lot harder

Getting a home loan is getting a lot harder

Most people don’t apply for a home loan many times in their life. Even if you’re just renovating or refinancing, it may have been 3–10 years since you last applied for a home loan and there have been a lot of changes in the lending market over that period so that what used to be a relatively straight forward application process can now be a frustrating, and potentially costly, experience.

What has caused the changes in the market?

In 2014 the Reserve Bank got concerned about the sharp rise in house prices and requested APRA, the government watchdog for the banks, to tighten the ‘prudential’ lending regulations and hopefully slow the market, so APRA limited the banks to a maximum of 10% growth in investor lending over a 12-month period.

To meet these new requirements the banks raised interest rates on investment loans in some cases by as much as 1% almost overnight, as well as significantly tightening their loan application assessment policies. Chart one shows the impact that this has had on the growth rate of investor lending.

Chart1: Investor lending slowed sharply after APRA tightened regulations

mortgage lending

Source: JP Morgan

Then in April 2017 APRA introduced additional macro-prudential measures which capped interest-only lending at 30% of all new loans issued. Around six months after that was introduced, home prices in Australia’s major east-coast housing markets began to decline. Chart two shows the significant fall in year on year house prices in Sydney and Melbourne particularly.

Chart 2: Melbourne and Sydney home prices started to decline after APRA restricted interest-only loans

Capital city hp

Source: JP Morgan

Throughout this period APRA has also been working closely with banks to develop stricter underwriting standards for both investor and owner-occupied loans. This tightening, combined with the public shaming at the Royal Commission into Financial Misconduct, has forced banks to take note.

How has this affected the lending process?

There is no doubt the regulatory changes have been introduced to make sure our financial system remains unquestionably strong, however, for anyone intending to apply for a home loan there are consequences you should be aware of.

1. More paperwork – In the past lenders have been able to accept that what you entered on your application was correct, but today they will require you to verify much more of your financial situation with documentary evidence in the form of bank statements. Often the submission of one statement leads to further requests which can be frustrating for all involved.

2. More questions – Banks are required by their regulators to keep evidence explaining why they assessed your application in a certain way. While something may seem obvious to you as the borrower, the banks may request an explanation in writing to ensure they have documentary evidence.

3. Living expenses – Currently banks ask that you estimate your living expenses and then take the higher of your estimate or the Household Expenditure Method (HEM). HEM is a national standard based on a few things, including where the borrower lives and the number of dependent children, and then assumes a basic standard of living. History has shown borrowers generally have a surprisingly vague understanding of their monthly living expenses and tend to underestimate this figure, and banks are now starting to require more evidence in the form of transaction or credit card statements to prove actual expenditure, rather than simply taking an estimate. A review of the HEM model is also underway.

4. Inflexible – Each bank has a list of criteria that need to be met to gain loan approval and these are documented in the bank’s lending policy. Banks have been instructed by APRA to strictly adhere to these policies and make very few exceptions. As a result we have seen an increasing number of declined applications for circumstances that may seem like common sense to the borrower, but unfortunately do not meet the specific requirements of the lender’s policy guide. Each bank’s policy guide is different, and it pays to speak to someone who has knowledge of these subtleties.

5. Principal and Interest (P&I) repayment – with such a regulatory emphasis on investment and interest only loans, it doesn’t take much to realise that much of the recent lending growth has come in the form of P&I repayment. Depending on your personal circumstances and lending objectives, you may consider paying principle and interest (P&I) instead of choosing an interest only loan.

These are just a few examples in which applying for a home loan has become significantly more difficult in recent times, but they highlight the importance of speaking to a professional to ensure you have the right structure and preapproval before you make an offer on a property. Where appropriate, we can also help you to apply with a non-bank lender that is not affected by APRA’s restrictions.

It’s ugly and embarrassing, and it’s not over yet

It’s ugly and embarrassing, and it’s not over yet

The banking royal commission has exposed the very worst of the financial planning industry and, after what’s hit the fan, any self-respecting adviser is left dreading being tarred by the same reputational brush. Penalties handed out to those found responsible need to be severe and entrenched structures in the industry will have to change.

I’ve written about this only a few months ago, but the revelations over the past couple of weeks are making the bell ring louder to call time on the vertical integration model of financial services because it incentivizes people, from the boardroom down, in all the wrong ways.

Some twenty-odd years ago the banks hit on a new strategy to get their hands on Australia’s pool of superannuation that enjoys(?) government-mandated growth. They already had a bird’s eye view of what their customers’ finances look like, and they bought or built financial planning and funds management businesses together with the ‘platforms’ that connect the two, and constructed their own massive, money making eco-systems.

It’s a ticket-clipping machine: a bank sees you have a healthy credit balance in your account so suggests you talk to one of their friendly financial planners, who charges (cha-ching) for a financial plan that recommends you set up a wrap account (cha-ching) so you can invest in a bunch of managed funds that happen to be owned by the bank (cha-ching) and protect yourself with the bank’s insurance policies (cha-ching).

The advisers might be paid a base salary but almost invariably they’ll get a bonus based on revenues from product flogging, and what’s worse, the bonus will be bigger if they flog the bank’s own products. Not all the products are necessarily bad, but when incentives are as skewed as that you can see how it’s odds on that a client will not end up with the best available. Economics is largely a study of incentives, and that structure was always a disaster waiting to happen.

Something to make clear though, while it takes dodgy advisers to flog those products, the royal commission has made it abundantly clear the managers who were supposed to be overseeing them were as much to blame. Turning a blind eye to egregious behavior might not be the same as actively endorsing it, but it’s a long way from actively stopping it too. As for having policies that promote charging clients for nothing and interfering with what are supposed to be independent reviews, as the saying goes, the fish rots from the head.

Something else that may need to be part of the debate is how the banks are under relentless pressure to increase earnings every year. That kind of pressure always rolls down hill and pressure can make people do things they otherwise wouldn’t. It’s little comfort to the customers that suffer poor or conflicted advice that it’s likely their super fund will benefit from higher bank earnings.

An obvious way to change things that’s already been acknowledged by Commissioner Hayne is changing the remuneration incentive from maximizing revenue to maximizing compliance and customer satisfaction. Exactly how you do that though is quite another thing.

Already politicians are promising tougher penalties and it’s clear they need to be nasty enough to do serious potential harm: fines need to be big enough not to be written off as a cost of doing business. The ACCC’s Greg Sims is talking about being able to fine a company 10% of its revenue – in 2017 CBA earned $26 billion in revenue, now that’s a disincentive! The other thing that needs to happen is for managers or executives guilty of the worst behavior to go to jail; don’t slap a fine on the company that shareholders end up paying, the risk of spending time in the big house could see some serious changes to compliance!

On the other side, you’re never going to get a Royal Commission or media exposé to look at the good things an industry does. There remain thousands of ethical, hard working financial planners who genuinely prioritise their clients’ best interests and there are thousands upon thousands of stories of clients whose lives have been transformed through getting good financial advice. 80% of Australian baby boomers who work with a financial planner believe they are better prepared for retirement, and in the US out of 1,287 millionaires surveyed by Fidelity in 2016 the 56% who had an up to date financial plan felt 20 times more optimistic about the future.

The fastest growing area of financial planning is self-licensed advisers, or IFAs (Independent Financial Adviser). If your business isn’t answerable to a third party owner that’s pressing for growth at all costs you can make decisions that are only for the good of a client. There’s no doubt our industry has a lot of work to do, because at a time when saving for retirement is complex but critical, clients need to be able to know it’s their interests that are being served.