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The Royal Commission
Anyone applying for a home loan today faces a much more rigorous approval process than in the past, largely due to changes prompted by the Royal Commission into Misconduct in the Banking, Superannuation, and Financial Services Industry. This inquiry, which concluded in 2019, uncovered numerous instances of poor lending practices by major lenders. A particularly troubling finding was that many banks failed to properly verify the living expenses of home loan applicants. This lack of due diligence often resulted in people being granted loans they couldn’t realistically afford to repay, leading to financial distress.
The Royal Commission also highlighted the limited regulatory enforcement by ASIC, one of the key financial regulators. The absence of strong penalties for non-compliance meant that banks had little incentive to strictly adhere to lending guidelines. In response, ASIC has since promised stricter oversight, and lenders have adopted a more thorough approach to assessing home loan applications. Borrowers are now required to provide detailed evidence of both their income and expenses, often down to the smallest expenditures. While these measures aim to protect borrowers and lenders alike, they have made the process of securing a home loan far more demanding.
Bigger deposits
Falling property prices in Australia’s major cities might seem like an opportunity for prospective home buyers, as lower prices mean a smaller loan is required. However, the banks’ response to this situation has been to demand larger deposits as a safeguard against potential losses. A bigger deposit reduces the bank’s risk, especially in an environment where home values could continue to decline.
For home loan applicants, this means more time and effort are required to save the necessary funds. A deposit of 20% or more is often preferred by lenders, as it can also eliminate the need for costly Lenders Mortgage Insurance (LMI). However, saving such a substantial amount while managing everyday expenses and rising living costs is no small feat. This requirement for larger deposits has been a significant barrier for many first-time buyers, making the home loan process feel like a distant goal rather than an achievable milestone.
Stringent stress testing
Before the Royal Commission, banks already had to adhere to strict guidelines for stress testing home loan applicants. This process, enforced by APRA, ensures that borrowers can still meet their repayment obligations even if interest rates rise significantly. Currently, banks assess an applicant’s ability to repay their home loan at a hypothetical interest rate that is often several percentage points higher than the current rate.
For example, while a borrower might secure a home loan with an interest rate of less than 4% per annum, lenders assess affordability based on rates exceeding 7% per annum. This conservative approach reduces the risk of borrowers defaulting on their loans if economic conditions change or rates increase. However, it also limits how much a person can borrow, requiring applicants to have not only a larger deposit but also a higher disposable income to demonstrate they can comfortably meet future repayment obligations.
Being prepared
Navigating the more challenging landscape of securing a home loan requires careful preparation and financial discipline. The first step is to increase savings, which often means reducing discretionary spending. While this might seem daunting, tools like budgeting apps can help you track expenses and identify areas where you can cut back. By setting a realistic budget and sticking to it, you can steadily grow your deposit fund over time.
Keeping detailed records of your financial activity is also essential. Lenders will scrutinize your spending habits, savings history, and overall financial management. Being able to provide years of consistent documentation showcasing responsible financial behavior will strengthen your home loan application.
It’s also important to start your preparations as early as possible. Building a strong savings history and demonstrating responsible financial behavior over several years rather than months can significantly improve your chances of approval. Additionally, shopping around for the best home loan options is crucial. While starting with your current bank might feel convenient, exploring offers from non-bank lenders and mortgage brokers can sometimes yield better rates and terms tailored to your needs.
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