What the banking royal commission means for borrowers
Did you read our last Q&A with Paul Blake from MoneyQuest Finance Specialists?
The one where Paul went into great detail about all things finance specific to Owner Builders? If you haven't, it's a great read so click here if you're keen!
Anyway, we felt a follow up Q&A was in order given the recent findings from the banking royal commission and what they mean for borrowers.
Another valuable read so ENJOY 🙂
What changes have you seen since the royal commission?
The banks started to look at and change their lending practices around the time the royal commission started – December 2017.
The main change that affects clients is living expenses.
The banks are very diligent about how a client spends day-to-day and what impact that then has on their potential to borrow.
Pre royal commission, the banks would use an average cost of expenses for 2 adults and 2 kids.
Now they want further detail on what people are spending their money on and that's having an impact on what people can borrow.
How do the banks get that level of detail?
Each bank has a different way of doing it but generally they look at the last 3-month period.
In particular, spend items they look at include groceries, insurance, child care, car expenses (fuel, registration), telephone (internet), utilities (power, gas, water), school fees, entertainment, money for holidays, personal care (clothing, hair), medical expenses (medication, health insurance), rates, body corporate and any other day-to-day spend over and above.
If you have a credit card with a limit of $10,000, the monthly repayment is also factored in.
Some banks are happy with the conversation I have with clients however other banks want to see exactly what client’s are spending.
The impact on clients is the more they spend day-to-day, the less they can borrow. Once all expenses are calculated, a borrower needs a positive balance.
GOOD TIP: A good tip for client’s is to sit down in advance of getting finance and go through what they spend then consider altering those living expenses (based on income) and going from there.
Self-discipline and budgeting is key.
Is that the only significant change to getting finance?
Banks have definitely tightened up their lending policies but they’ve been doing it over some time.
With regards to Owner Builder loans, the policies are pretty much the same i.e. they can only borrow 60% of total build amount.
With the way the property market is at the moment we may see some loosening of credit policy. They're starting to do that for investors, allowing interest only borrowing.
The banks together with the RBA and the government are looking at ways to make it easier to get finance in order to get the property market moving again.
Two other changes are the following:
1. Additional income
How the loan is serviced is based on income however the other thing they’ve changed is their view of additional income like bonuses, commissions and rental income.
Say someone earns $10,000 commission the banks will only take into account 80% of that amount so $8,000.
2. Loan servicing rate
The other thing borrowers should be aware of is the loan servicing rate.
If you borrow money and the interest rate is say 4%, the loan-servicing rate used by the banks is 7.25%. This allows for a buffer for interest rate variances. Some lenders calculate at 8%.
Let’s say you borrow $500,000. The repayments are calculated by the bank at 7.25% (or 8%) and not the 4% interest a borrower will be paying on the loan.
How about structure of bank accounts? Is it worth setting bank accounts for daily spend, savings, rainy day account?
Yes. Make it part of the budgeting process per the tip above.
Then once a client does borrow, if there is a savings account, it’s worth considering an offset account against the loan account.
For example, say a client has a $100,000 mortgage and $10,000 in an offset account – they’ll only pay interest on the difference of $90,000.
Money in the offset account doesn’t reduce the monthly payment it just reduces the interest that ultimately reduces the term of the loan. The repayment amount is still based on the total loan amount ($100,000).
Reducing the term of the loan is the benefit of an offset account.
Also, an offset account is based on a daily balance. So you might have $5,000 in the account one day, $10,000 the next and $2,000 the day after – it’s calculated on the daily amount.
I assist my clients with budgeting and look at whether an offset account will ensure they get the most out of the loan scenario.
Are loans taking longer to get approved?
The banks are doing greater due diligence on their end and Mortgage Brokers also have compliance on their end.
Doesn’t matter whether it’s a bank or broker, the emphasis is put on the person submitting the loan to make sure they’ve crossed the t’s and dotted their i’s as far as making sure that the loan is compliant in relation to living expenses and servicing.
If everything marries up then the banks are satisfied.
In relation to Owner Builders, there’s more involved in the loans because you’ve got to have approved permits and a detailed cost of the build etc.
Do you recommend Owner Builders speak to a bank or a broker very early in the process?
Yes because they need to determine how much they can borrow and if they’ve got enough equity to do it. It’s worth discussing the possible end value of the build, if their are any outstanding loan balances on the property and what cash they’re going to put in.
Since the royal commission, there's been negative press about the mortgage broking industry, is it business as usual?
There were 76 findings in the Royal Commission of which the government is happy to pass 75.
The one finding yet to be decided from the royal commission is around the banning of trail commissions and upfront commission for brokers.
To reiterate, there is no cost for what a Broker does for a client.
Brokers are paid by the lender on the amount borrowed and a trail commission on the outstanding balance on a monthly basis.
It’s been structured this way for over 20 years.
The royal commission finding wants to turn it into a fee for service process so if a broker sees a client there will be a fee incurred by the client. And likely, the same fee will be charged by the bank if a client goes direct to the bank.
Under this proposal the client is the one to lose out because they’ll be paying for something that they didn’t pay for previously.
That’s where there was a lot of uproar. A lot of people depend on mortgage brokers to get their finance.
Under the fee for service model, the major banks would have a competitive advantage because smaller lenders rely on brokers for business.
What’s the sense in the industry, do you think fee for service will be introduced?
The Morrison government weren’t prepared to do it straight away because it would have affected about 17,000 mortgage brokers around Australia plus about 5,000 other people in the industry.
Originally the government said they’d cut trail commissions on 30 June, 2020 but still allow upfront payment to brokers from the banks.
Now the government have said they’re not going to cut trail commissions on 30 June, 2020 rather they’ll review the entire industry in 3 years time.
The issue is, the Labour party, although they've agreed in principal, haven’t agreed to putting everything on hold for 3 years.
If they moved to a fee for service would it be a fixed fee for both brokers and banks?
It’s still yet to be determined. It would be likely that the government would legislate a fee and that same fee amount would have to be charged by the bank and the broker.
Have you found that consumers have been put off coming to Mortgage Brokers?
No, it’s business as usual.
The broking market works well as it does the work on behalf of the client for the bank. A client doesn’t get a better deal by going to the bank directly and it means they don’t have to deal with the bank directly.
There are cowboys in every industry including the broking industry. The majority of the 17,000 brokers are doing the right thing by the client and if they don’t, a client has the freedom to change to someone else.
What should an Owner Builder expect from a Mortgage Broker?
1. Knowledge and experience – even if they’re new to the industry.
2. Customer service is paramount – decent turn around times and doing what they say they’ll do.
3. Availability – whether it’s on the phone, face-to-face, during or after hours.
For me, I wanted to be different from the banks. Banks are only open from 9.30am and 4.00pm four days a week and til 5.00pm on a Friday. On top of my experience, I'm known for making myself available to my clients, seeing them anywhere at anytime – it's all about convenience.
It’s tough for Owner Builders getting finance but it’s really worth reaching out and speaking to a broker to understand the options available to borrow money.
Gosh we love our job interviewing people like Paul. What great information he's provided in this follow up interview. Thank you Paul Blake!
If you’d like to discuss your Owner Builder lending requirements with a Broker who’ll work hard for you, don’t hesitate to contact Paul on 1300 345 747.