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Have you recently applied for a home loan for an investment property on your principal residence?
Because unbelievably, many of you who have had a mortgage application accepted have no idea that you have been granted an interest only (IO) loan!
A UBS survey of recent mortgage applicants found that, rather than the 35% of loan applicants applying for an IO loan per APRA’s research, the actual number who replied to the UBS survey was 24%.
So, one third of respondents have zero idea what the terms of the loan they took out are!
Even more disturbing: the amount of these applicants who are under severe financial stress, and yet still receiving a loan.
These types of stories breaking out are intricately linked to the turning of the 18.6-year Real Estate Cycle (REC).
So, they function as a guide to the beginning of the second, more speculative, half of the REC that we can follow.
So, what was in this UBS report, why are the results important, are you affected by them and if so, what should you do about it?
Read on.
The more things change, the more they stay the same.
This really isn’t a new issue to be frank.
Back in 2018, during the Royal Commission into banking and lending, the inclusion of mortgage brokers and intermediaries in the commission showed their focus on misconduct in the mortgage market.
Do note, though, as part of the big banks acquiescing to being called before the Royal Commission that they first sell their financial broker arms to limit the blowback from the Commission’s findings.
Go figure.
The thing is, the Royal Commission was ordered by government due to what was occurring the previous decade.
And with APRA (Australian Prudential Regulatory Authority) taking less than six months to begin to unwind the findings made means we are once again facing similar behavior.
Here is how it was reported during the time via UBS analyst’s article.
“Overstated borrowers’ income is raising the risk of mortgage mis-selling and such misconduct poses material risk to banks… they expressed concern over the “weak” mortgage underwriting standards of banks.
In a research note, the analysts said their findings regarding high levels of mortgage borrowers’ gross household income support their concerns over factually inaccurate mortgage applications that are “permeating” the country.
They called these high levels of income as “highly improbable”…”
And this has brought on the proliferation of so-called ‘liar-loans.’
Left unchecked, it’s these types of developments that will bring the system down. Which means you will be at risk if you are highly leveraged at the wrong time.
And once again, brokers are in the firing line for their “factual inaccuracies.”
Here’s the rub.
According to APRAs loan statistics, over 35% of loans written up to June 2021 were an interest only loan.
Yet the results from UBS own survey returned a different number; only 24% of respondents said they took out an interest only (IO) loan in the past 12 months.
That’s 11% difference, not a simple rounding error.
Per the report (emphasis added):
“…the most likely explanation for the lack of respondents indicating they have IO mortgages is that many customers may be unaware that they have taken out an interest only mortgage.”
Wow!
How can that be? Are these people being deliberately misled?
But another theory was put forward to explain this.
And that was, the huge divergence amongst applicants when it came to their checking terms or even their financial literacy.
Clearly then, there is a disconnect between the mortgagee, the broker, and the bank.
It smacks of getting a mortgage at any cost, regardless of the financial risk being taken.
Another way to interpret these results is the fact that there must be a degree of financial stress being experienced.
When the truth hurts.
How would we know this though?
What exactly is the link between these IO loans, lack of financial literacy and the level of financial stress?
Firstly, IO loans are cheaper to service, as there is no principal to pay, only the interest.
Mostly used for investment properties, owner occupiers can also apply for them.
And the main reason for this is the monthly cost of the mortgage is lower, so lowering your repayments would be welcomed.
Add in the fact the broker receives commission from the bank which issues the loan, and you can see an incentive to get the approval.
And if the UBS survey is correct, the fiscal impact could be catastrophic.
They looked at the channel used to secure the loan, be it direct from the bank or via a third party like a broker.
From the survey, UBS found that borrowers under moderate stress favored banks over brokers (46% to 30%).
Borrowers who identified as under high stress though favored brokers over banks (42% to 20%).
Seems that banks are more risk averse over who they grant a mortgage.
Whereas brokers seem to still push for the loans to be accepted despite the higher stress being experienced.
Amazingly the UBS survey reported that an astounding 69% of people with ‘liar loans’ in the broker channel claimed that it was the broker that suggested that they over/underrepresent to get approved.
Now, I’ll say up front I have no idea just how true these figures are, and whether they stand up to any scrutiny outside of the ones UBS applied.
UBS claim these results are not surprising as they align with their 2017 survey of the same thing.
Let’s say they are overstated by 50%. That’s still far too high for comfort.
Time to apply our real estate cycle lens.
What can the 18.6-year Real Estate Cycle history tell us?
We know that the credit that becomes available once the second more speculative half of the cycle commences gets completely out of hand.
The second half has now begun, and so this type of thing is only going to get worse from here, not better.
This is when FOMO really kicks in and any method that can be applied to secure a loan is fair game.
Hence the explosion of so-called ‘liar loans.’
You really need to be on your toes when it comes to choosing a good broker.
From my own experience, your broker should not be instructing you to misrepresent, deliberately leave out certain debts or overclaim your income just to get your loan approved.
A good broker has a practiced eye and knows all the simple errors and mistakes that applicants make.
Recall 70% of respondents said their broker encouraged them to not do the above!
It gets worse.
Because what I didn’t tell you is that 22% of these same respondents claimed it was the bank themselves that encouraged them to fudge figures!
What is going on here?
Well, it’s the real estate cycle folks.
You are witnessing the future of lending in both Australia and across the world.
Standards will continue to fall; regulations will be rolled back and I’m certain we will see the reintroduction of low-doc or no-doc loans soon.
APRA’s lift in the minimum buffer of 3% (previously 2.5%) above a mortgage loan rate is designed to help slow the market down.
However, non-bank lenders are exempt from this standard. If you really want to fudge your mortgage application, which bank would you apply to?
With loans written by non-bank lenders increasing from 6% to around 12% since March 2020 this is precisely what’s occurring.
This will end badly for all involved.
Its time you get ahead of this ticking time bomb and get educated.
Start here with a membership to the Boom Bust Bulletin.
Learn the history of the 18.6-year Real Estate Cycle, why it continues to repeat and most crucially the timing to make the right moves when you need to do them to maximize the opportunities that the cycle presents.
Know this, in a few years from now the interest only period will end, and these loans will return to principal and interest loans.
Do you know what the interest rates for these P&I loans will be near the end of the decade?
Will you be able to afford an interest rate hike above 5%? What if you look to refinance and the value of your property has fallen?
Knowledge of the real estate cycle will give you advance warning for when these scenarios become fact.
APRA wants the minimum buffer to be 3% simply because it is forecasting the average home loan to be above 5% in a few years’ time.
This is how it has always been, find out now and prepare accordingly.
It could be the difference between keeping your home of your dreams or losing it.
Get this knowledge for only $4USD a month. Incredible value.
Best regards,
Darren J Wilson
and your Property Sharemarket Economics Team
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