Commonwealth regulation of lenders, brokers, and other intermediaries and the new National Credit Code (NCC) commence in just four weeks. What's this mean for the finance industry?
Business as usual
Our key message is "don't panic". To a large extent it is business as usual. The NCCP Act and the NCC changes were not designed to revolutionise the way lenders and brokers do business but rather to pass regulation to the Commonwealth, through ASIC, and to introduce a registration/licensing scheme.
The key changes are as follows:
- Loans predominantly used to purchase real estate predominantly used for residential investment purposes, and refinancing those loans, will be regulated by the NCC. The key date is the date of the contract, not the date of settlement. Residential investment loans made pursuant to a contract dated before 1 July 2010 never become subject to the NCC unless there is a new credit contract.
- All participants in the credit industry need to have been registered or appointed as credit representatives. Most aggregators are offering their members a choice of being registered and in due course obtaining their own licence or being appointed as a credit representative.
- There are changes to the information statements used when documenting NCC regulated loans, a new direct debit default notice, and new procedures and documentation on default. [For details see Annexure B].
- Brokers and lenders (except ADIs) need to assess whether a loan is unsuitable. This requires an investigation into the borrower's requirements and objectives, enquiries about the borrower's financial situation, verification of that financial situation, and an assessment. A written copy (which can be electronic) of the assessment must be kept stating how long the assessment applies for. [For details see Annexure B].
- Businesses need to check that businesses they deal with that conduct credit activities are registered or appointed as a credit representative. It is a criminal offence to deal with a business which should be registered or appointed and isn't.
What's yet to come?
There are four key pieces of information still to be announced by the Government:
- whether trustees need to be registered or are exempt
whether referrers can provide contact details to lenders and brokers
- exemption from commission disclosure for mortgage managers and other non‑bank participants
- the format for credit guides, quotes, credit proposal documents, and credit assessment reports.
The first two are expected to be dealt with in new regulations released within the next two or three weeks. The others will take several more months as these requirements don't commence until 1 January 2011.
The story so far
Businesses have found it easy to register.
It will be interesting to see how many businesses are locked out by failing to register prior to 1 July 2010. Generally, lenders and lessors of record need to be registered/licensed in their own right and cannot rely on being appointed as a credit representative of another entity. Brokers who fail to register can probably fix the problem by being appointed as a credit representative.
Businesses can appoint credit representatives as soon as they are registered, but the appointments only take effect on 1 July 2010. Notification to ASIC can only be lodged from 1 July 2010 and in respect of pre 30 June 2010 appointments, they must be notified within 15 business days of 1 July 2010.
Gadens Lawyers are continuing to work with the MFAA to provide pro forma documents and procedure manuals. MFAA members should read the All in One Guide and the Summary of the Legislation available in the members section of the MFAA site. The MFAA site also provides a Q&A facility.
Some businesses may require assistance in customising the MFAA pro forma documents to their own business requirements as part of licensing.
The requirements for licensing need to be in place before lodging the licence application. All licence applications must be lodged by 31 December 2010. Gadens Lawyers can help you customise the MFAA documents for your business or create new ones.
Annexure 1 - CCC to NCC changes summary
The Uniform Consumer Credit Code is replaced by the National Credit Code on 1 July 2010. This report deals with the main changes and initiatives impacting on the mortgage industry.
- Extension of regulation to loans made to individuals and strata corporations predominantly for the purpose of purchasing renovating or improving residential investment property, and refinancing those loans. Residential property means land on which a dwelling is or will be affixed for predominantly residential purposes.
- New default notices and notices following default and consideration of hardship and postponement applications.
- Comparison rate schedules abandoned, but comparison rates in adverting retained.
- New business purpose declaration.
- A mortgage cannot be taken over essential household property (except antiques) unless the financier is selling the goods to the customer (terms sale).
- A mortgage cannot be taken over goods used by the mortgagor for earning income by personal exertion unless the value of the goods exceeds the amount specified in the Bankruptcy Regulations.
- If a debtor makes an application to amend a credit contract on the grounds of hardship, the lender must give written notice of the outcome of the application within 21 days of receiving the application. If the application is refused, the notice must state the reason for the refusal, the name of the lender's external dispute resolution (EDR) scheme, and the debtor's rights under that scheme. Hardship applications can be made in respect of loans where the principal sum is $500,000 or less.
- ASIC can apply for changes to one or more credit contracts in respect of hardship changes, unjust transactions, establishment and early repayment fees, and changes to interest rates.
- Direct debit default notices must be sent the first time a default occurs in payment pursuant to a direct debit authority. The notice must be sent to the borrower and any guarantor within 10 business days of the default occurring. The notice need not be given if the default is rectified before the notice is given. The notice need only be given once in respect of each direct debit authority.
- Additional information must be included in default notices including information about the lender's EDR scheme, that a credit reporting agency may be notified, and the rights to negotiate for payment relief for hardship under s.72 or postpone enforcement under s.94.
- After receiving a default notice, a borrower may apply within the 30 day notice period for postponement before enforcement proceedings are commenced. The lender must give written notice of the outcome of the postponement application within 21 days of receiving the application. If the application is refused, the notice must state the reason for the refusal, the name of the lender's external dispute resolution (EDR) scheme, and the debtor's rights under that scheme.
- Interest in advance is permissible for residential investment loans. (The higher/lower rate regime is not permitted).
- Existing UCCC forms may be used for two years after commencement (ie until 30 June 2012) if the form has the same effect or is the same in substance. If the new form contains more information than the old UCCC form, the additional information can be included in a separate document.
The change over date is determined by the date of the credit contract. Residential investment loans made by contracts dated before 1 July 2010 do not become subject to the NCC. However, loans which were regulated by the UCCC generally become subject to the NCC except the new $500,000 maximum for hardship and postponement applications does not apply.
Annexure 2 - Assessing whether a loan is unsuitable
This guidance is divided into three sections.
Part 1 – Outline of the legal requirements
Part 2 – Factors to consider in assessing whether a loan is unsuitable
Part 3 – Record Keeping
Part 1 - Outline of the legal requirements
Summary of the law
The responsible lending obligations contained in the NCCP Act require:
- making reasonable enquiries about the consumers' financial situation, and their requirements and objectives
- taking reasonable steps to verify the consumers' financial situation
- making a preliminary (brokers) or final assessment (lenders) about whether the credit is 'not unsuitable' for the consumer
- providing a copy of the assessment on request if assistance is provided (brokers) or credit is provided (lenders) – from 1 January 2011 only. This aspect is not dealt with in this document.
Credit will be unsuitable, if at the time of the assessment it is likely that:
- a consumer will be unable to comply with their financial obligations under the proposed credit contract, or could only comply with substantial hardship; or
- the proposed credit contract will not meet the customer's requirements or objectives.
If the borrower can only repay by selling the borrower's principal place of residence, it is presumed the loan will cause substantial hardship unless the contrary is proved. This presumption relates only to the borrower's principal place of residence. This presumption will not apply if the borrower has to sell other assets, for example an investment property. However, relying on sale of assets needs to be reasonable in all the circumstances of the case.
When must the assessment be made?
Brokers must make the preliminary assessment within 90 days of when the credit assistance is provided. This will be when the broker assists the borrower to apply for a loan, lease, or an increase to a loan. Assisting a borrower arrange a settlement is not credit assistance, and so the assessment does not need to be within 90 days of loan settlement.
Lenders and lessors must make the assessment within 90 days of when the loan or lease contract is entered or principal sum is increased (120 days if the loan is used for the purchase of residential property and is secured by a mortgage over that residential property). The time limit for new loans relates to the date of the credit contract, not the loan settlement date, whereas the time limit for principal increases relates to the date the principal is increased, not the contract date.
If an assessment becomes 'stale', a re-assessment must be made. The re-assessment can usually be less rigorous than the initial assessment as the original information can be relied upon when appropriate.
The assessment must state the period the assessment covers – see s.116, 129, 139, and 152 NCCP Act.
RG209 is ASIC's non-binding guidance on how it expects these requirements to be discharged in practice. RG209 states that the requirement is scalable. By this ASIC means that what is required will change depending on:
- the potential negative impact on a consumer
- whether it is evident that the consumer has limited capacity to understand the credit contract
- if the product is a reverse mortgage
- if a debt consolidation service is required.
Accordingly, what is reasonable can vary significantly from doing very little (in respect of an existing customer or someone that the broker or lender knows well, or for small loans where the consequence of default is small) to quite extensive (highly geared home loans where servicing is tight).
Although this range of enquiry is wide the law will not be satisfied by:
- pure asset lends where there is no enquiry as to serviceability at all
- self declaration loans where there is no verification of the financial information.
On the other hand, if the loan product doesn't require serviceability for a certain period, there is no need to demonstrate an ability to service the loan during that period.
Impact of other NCCP Act requirements on loan assessment
There are two other key requirements in the NCCP Act which could impact on the unsuitability test, namely:
- the obligation to act efficiently, honestly, and fairly
- the obligation to ensure clients are not disadvantaged by any conflict of interest.
Read literally these provisions could significantly impact on the type of loans a broker could arrange or a lender could provide.
- a completely efficient, honest and fair broker or lender might tell a borrower to go to someone else who has a better product
- a broker who receives a commission from a lender might suggest that the borrower contact the lender directly as a cheaper loan might be available where there is no commission.
Although it's not free from doubt, this extreme interpretation of these two requirements is incorrect as it would change the requirement from a prohibition on providing an unsuitable loan to a requirement to arrange the very best loan. That is clearly not the intention of the legislation. However, it is important that your disclosure documentation clearly explains what your business can and will do. For example, a mono-line broker can only arrange loans through its funder and so its disclosure would need to explain this.
Commission bonuses and minimum volume requirements
The mere fact that a broker receives more commission from one lender does not mean that the borrower is being disadvantaged by a conflict of interest. However, if the broker recommends a less desirable loan because of increased commission, there will be a breach of the legislation.
The difficulty with that proposition, of course, is determining which loan is best, the test for which has not been discovered as graphically illustrated by the failure of comparison rates. Some more expensive loans may be more suitable because of flexibility, ease of approval, service levels, geographic location etc. Brokers will need to make an honest and fair assessment and be able to defend that decision.
Against that background, the following test can be applied to satisfy both the conflict of interest and general conduct obligation, namely "I will not act unfairly and my services will be clearly disclosed in my credit guide". Prior to the commencement of credit guides on 1 January 2011, the disclosure should be in the broker's FBC.
High interest rate loans
Consider a broker or lender offering a loan of $5,000 at 30% per annum for three years. There may be more suitable loans for this borrower, such as credit cards, or redraws. However, a mono-line broker or lender can still provide this loan so long as the loan is not unsuitable.
A similar but less dramatic example occurs when a major bank has different priced products. The bank is not required to always sell the cheapest rate it has.
However, it is important that there is no actual or implied representation that this loan is the 'best'.
Part 2 - Factors to consider in assessing whether a loan is unsuitable
1. Credit product considerations
- Amount of credit (whether 'unrequired' credit is offered)
- Type of facility (basic / sophisticated, short / long term, secured / unsecured, small personal loan / housing loan, bridging loan, straight refinance, loan consolidation, credit card, store card, linked credit contract, lease, reverse mortgage)
- Features of facility (interest only, principal and interest, variable / fixed interest, split option, redraw option, offset account option, line of credit, prepaid interest that is either capitalized or deducted from loan amount at settlement, balloon payment)
- Type of security given (and how its effective life relates to the term of the loan)
- Cost of obtaining the credit (whether deducted from loan amount, or capitalized on to loan amount and therefore attracting interest)
- Cost of exiting the current credit facility (termination fees, exit fees, break costs)
2. Consumer specific considerations
- Age (will the term of loan extend beyond retirement age)
- Marital status, domestic circumstances (number of dependents)
- Occupation and industry type (mainstream or cottage)
- Employment status (whether full time, part time or casual, student, semi retired, self employed)
- Income level (regular / irregular)
- Savings and credit history
- Current overall credit commitment
- Financial literacy (ability to understand the credit transaction and the risks associated with non compliance)
- English language ability
- Purpose of the credit
- Amount of credit required
The motive behind entry into the loan transaction such as:
- filial considerations: elderly non working parents helping out their kids to purchase either a home or business
- tax driven investment strategy: borrowing on existing equity to purchase investment property.
3. Types of enquiry
Any enquiry made by the provider should also be proportionate and referable to a number of known or apparent factors, including:
- the nature of the credit product, and whether the consumer appreciates the risks that particular features of the product may present given the consumer's circumstances
- the amount of the credit
- the borrower's credit history
- the borrower's income-producing activity, age, language skills and general demeanor
- the borrower's domestic situation
- the borrower's saving history
- the borrower's expenditure.
4. Making an assessment
Commonly used loan affordability calculators are suitable for making the assessment. Once the serviceability is calculated using these calculations, it is normally not necessary to provide for a further buffer as that would result in double counting. However, when special circumstances are known (eg impending child birth, sickness etc), an additional allowance may be appropriate.
5. How low can you go? (Lo-doc and no-doc lending)
It appears that no doc lending (ie a pure asset lend) will not comply with the NCCP because the NCCP imposes an obligation to make reasonable enquiries about the borrower's financial situation and take reasonable steps to verify that situation. It seems that it can never be reasonable to make no enquiries as to the borrower's financial situation in relation to an NCC regulated loan.
On the other hand, lo doc lending is still possible. What is reasonable has been called by ASIC as scaleable. That means that you need to look at all the circumstances of the case.
In some cases (for example a low LVR loan to an experienced customer), minimal enquiries and verification will be sufficient. There will be some cases where stated income from a borrower, unsupported by an accountant, or from a borrower supported by the accountant will be acceptable.
The emphasis on some cases is deliberate and important. While there will be cases where stated income is sufficient, there will be even more cases where stated income is not sufficient. It depends on the circumstance of the case. This is what ASIC refers to the scalability. The trick is to devise guidelines for when stated income is acceptable and when it isn't. It will rarely if ever be acceptable not to enquire into and verify income of PAYG borrowers.
The obligation is not only to obtain information regarding the borrower's financial situation but also to take reasonable steps to verify the borrower's financial situation. Generally, that will require some positive steps to verify the information provided by the consumer.
Although, these restrictions only apply to loans regulated by the NCC, it's important to remember that loans which are not regulated by the NCC can be varied or set aside under various legal doctrines. In several cases courts have varied or set aside unregulated loans on the basis that they are unconscionable.
6. Other items which might be relevant in determining whether a loan is unsuitable
Besides obtaining and verifying financial information, there are other important aspects which will go towards determining whether a loan is unsuitable:
- the procedures used to verify the identity of the borrower
- how money is paid on settlement. If money is not paid in accordance with the stated purpose, there is a good chance the loan will be unsuitable, and there is increased risk of fraud or forgery tainting the transaction.
Part 3 - Record Keeping
The NCCP Act does not prescribe a specific method for keeping records of loan assessments. However, in order to demonstrate compliance with the law, brokers and lenders will need to keep a record of the steps they took to:
- make reasonable enquiries
- verify the consumers' financial situation – there is no need to verify all the financial information you collect
- make an assessment
The assessment must state the period the assessment covers – see s.116, 129, 139, and 152 NCCP Act.
From 1 January 2011, lenders and brokers will be required to provide a copy of the assessment on request if assistance is provided (brokers) or credit is provided (lenders). Further guidance on how to discharge that obligation will be provided in about October 2010.
In the meantime, businesses need to establish a system (preferably IT based) to capture this information. Where a broker is a credit representative, it will usually be appropriate for the licensee to maintain this record with the credit representative having access to it.
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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.