Dispelling low doc misconceptions

In the heady days before the global financial crisis (GFC), low doc loans accounted for anywhere up to 25 per cent of all mortgages written, according to data from the Australian Bureau of Statistics.

Today, however, the story is somewhat different.

According to data from JP Morgan, low doc loans currently account for less than 2 per cent of all new mortgages written.

Why? According to various key industry stakeholders, there are many reasons why low doc mortgages have fallen foul of brokers. And, while some of these reasons are sound, others are driven by long held misconceptions.

The Adviser spoke to Australia’s leading low doc lenders and aggregation heads to dispel some of the most common myths surrounding low doc lending, and to give brokers the confidence to write this type of product in the future.

As RESIMAC’s chief operating officer, Allan Savins, explains, low doc lending represents a “potentially lucrative” market for mortgage brokers and those who fail to write loans in this space are “missing out on a lot of business opportunities”.

“More than 20 per cent of the Australian population is self-employed, so there are a lot of potential borrowers in the market who have a genuine need for a low doc loan,” he says. “As such, brokers who fail to target this market are shutting the door to good business opportunities.

“I believe there are a lot of misconceptions out there about low doc mortgages, so it is up to us and the various industry bodies to dispel some of these myths.”

NCCP PROHIBITS BROKERS FROM WRITING LOW DOC MORTGAGES

According to recent research conducted by The Adviser, many brokers believe the National Consumer Credit Protection Act (NCCP) effectively stopped them from writing low doc mortgages.

Brokers believe low doc mortgages do not satisfy the “responsible lending requirements” outlined under the NCCP, the research found.

They believe the higher interest rates associated with this type of mortgage make this product “unsuitable” under the legislation.

When asked whether or not NCCP had stopped brokers from writing low doc mortgages, a majority said ‘yes’. Of the 490 respondents, 50.6 per cent said yes, while the remainder said they continued to write low doc mortgages after the implementation of NCCP.

The widely held belief that NCCP prohibits brokers from writing low doc mortgages was first given legs when this type of mortgage was singled out as an area of compliance concern in an Australian Securities and Investments Commission (ASIC) review late last year.

The review, which looked at 16 mortgage brokers’ compliance in the six months since NCCP regulations were introduced, pinpointed low doc loans as an area at risk of non-compliance with the responsible lending requirements where credit assistance was provided.

The major risks in terms of non-compliance with the responsible lending provisions for loans promoted as low doc were the steps taken to verify a consumer’s income, Greg Kirk, senior executive leader for deposit takers, credit and insurers, at ASIC says.

“The requirement is for brokers to make reasonable inquiries about the borrower’s needs, objectives, financial circumstances and an active effort to verify those financial circumstances when assessing suitability for any proposed loan,” he says.

“The key risk identified was the brokers taking inadequate steps to verify the consumer’s income and other financial circumstances.”

Given that low doc loans compliance with responsible lending required a bigger shift from past practice than standard mainstream home loans, the review placed particular emphasis on brokers who marketed themselves as providers of low doc loans.

While the brokers were aware that the review was taking place, low doc loans were still identified as a risk area when it came to the brokers complying with the responsible lending obligations.

“Loans promoted as low doc were a particular focus given the role these products played in the lead up to the US sub-prime crisis and in equity stripping, as identified in ASIC’s March 2008 report, Protecting Wealth in the Family Home,” ASIC commissioner Peter Kell said in November last year.

While, overall, most brokers were fulfilling the new responsible lending obligations and attempting to adhere, there was still room for improvement, the review found. On the back of this review, the number of brokers shying away from writing low doc loans recorded a “significant spike”.

But while a large proportion of brokers believe the NCCP has “stopped them from writing low docs” as the responsible lending requirements prohibited them from selling this type of product, RESIMAC’s Allan Savins says this is 100 per cent a myth.

Mr Savins believes brokers are scared of low doc lending due to their having limited knowledge and confidence around NCCP.

“The reality is, NCCP wasn’t created to provide a prejudicial or narrow based solution for all borrowers, it is fundamentally there to promote responsible lending,” he says.

According to Mr Savins, brokers’ misinterpretation of NCCP has not only impacted perceptions of both low doc products and who low doc borrowers are, but it is also having a detrimental effect on brokers’ ability to write more business.

“It’s about making reasonable enquiries around a borrower’s circumstances and declared income levels, and keeping a record of that,” he says.

Under NCCP, the Borrower Self-Certification Income Declaration is no longer acceptable in isolation, which is why other forms of alternative income documentation need to be sought.

“As long as brokers take the time to make reasonable enquiries as to the borrowers’ needs and financial position, and act with honesty and integrity, then there is no reason for brokers to be concerned about offering low doc styled loans to these borrowers.”

“Some brokers believe that the higher interest rates that come with low doc mortgages  ensure these loans are unsuitable under the responsible lending requirements of NCCP.

“Nowhere does the NCCP state that a specific interest rate makes a loan unsuitable, and this overall misconception has caused some brokers to needlessly stay away from servicing a legitimate segment of the market.

 “Moreover, the NCPP doesn’t differentiate low docs from full docs under the legislation, thus giving brokers permission to write both loans.”

Expanding on this point, Pepper’s director of sales and distribution, Mario Rehayem, says the legislation treats full doc loans in the same way as low doc mortgages – with the only point of differentiation being the income verification process.

“If you look at the Act in detail, there is no difference between a low doc and a full doc mortgage,” he says.

“Rather, the NCCP states that the way a broker collates a customer’s income verification is scalable.

“Under the NCCP, there are two types of borrowers: PAYG borrowers and self-employed borrowers. To obtain a loan, each borrower needs to verify their income and the way that income is verified differs – that is the only difference.”

LOW DOCS ARE DEAD

When the GFC hit, Australia’s lenders significantly tightened their lending criteria – effectively putting a stop to the popular days of low doc lending.

Pre-GFC, low doc mortgages were almost the same price as full doc mortgages, with just a few basis points separating the two loan types.

However, with the GFC, low doc interest rates climbed, leaving brokers believing Australia’s lenders had closed the door on this type of product.

According to Mr Rehayem, this is simply not the case and most lenders continue to offer low doc loans to genuine borrowers.

The reality is that 19.1 per cent of the market is self-employed. As such, there is a huge market for low doc products, meaning the “sector is alive and well”, Mr Rehayem says.

“Low docs were originally created for those individuals who did not have their financials up-to-date, or borrowers who had failed to lodge their tax returns. These borrowers weren’t bad or ‘dodgy’, they were still genuine clients with a genuine need for a low doc loan.

“Some companies choose not to complete their tax returns every financial year and that is their decision. Should they be punished because of that? Absolutely not.

“As far as I am concerned, as long as there are self-employed people in Australia, there will be a market for low docs.

“That said, there will never be a market for no docs.”

RESIMAC’s Allan Savins agrees and says that because a lot of brokers believe “low docs are dead”, lenders are risk averse and don’t offer low doc mortgage options any more, meaning the self-employed sector is “grossly under-catered”.

“The fact is, low docs are not dead.

“There is still a healthy demand out there for them and lenders that offer this type of product,” he says.

“Many self-employed businesses are under-capitalised or don’t have the right financials, but still have a genuine financing need. As a result, these products still have a place. In the pre-GFC market, low docs represented 25 per cent of all new loans written. Today, they represent 2 or 3 per cent.

“So, you have to ask the question: where have those genuine borrowers gone?

“Even if you say half of those borrowers wouldn’t get a loan today because we no longer have no doc loans, one day ABN loans, or PAYG low doc loans, it still leaves a market size of 10 per cent that is not being serviced.

“Brokers believe low docs are a thing of the past – but to me, there is a tremendous opportunity for incremental business from this particular segment of the market – if you believe solutions do exist.”

Mr Savins’ comments were echoed by Homeloans’ Greg Mitchell, who believes there is still “solid demand for low doc mortgages”.

“I do believe the low doc mortgage reputation has been tarnished.

“That said, there are still plenty of trustworthy, good self-employed borrowers that need this type of loan,” he says.

LOW DOCS ARE FOR THE ‘DODGY’ BORROWER

Since the days of low doc lending in the pre-GFC environment, the reputation of this type of product has deteriorated somewhat.

According to research conducted by The Adviser, a good portion of brokers believe low doc mortgages are somewhat ‘dodgy’, or used for ‘shady borrowers’.

Vow Financial’s chief executive officer, Tim Brown, says, while this sentiment is untrue and an unfortunate ‘myth’, it is a common misconception. Mr

Brown says the stigma around low docs can be attributed to the United States.

Mr Brown believes some brokers and lenders employed dodgy lending practices in the US, with many offering loans that boasted LVRs greater than 100 per cent. And while this was pretty prevalent before the GFC in the US, Mr Brown says nothing like it ever really happened in Australia.

“Most low doc loans had an LVR of below 90 per cent,” he says. “The lending standard in the US is much lower than it is in Australia. It is very difficult to get a product today if the income cannot be verified” – a statement Allan Savins agrees with.

According to Mr Savins, today, self-employed borrowers who wish to take out a low doc mortgage must verify their income in a variety of ways.

He says the days when borrowers would “guess” their income are “long gone”.

“Today, lenders use a variety of income verification tools,” he says. “At RESIMAC, we give clients the ability to provide BAS statements and bank statements in addition to the borrower declaration.

“We must remember that the intent of the product still remains. Low docs were first created for people who did not have up-to-date financials.

“NCCP has really just encouraged lenders to gather further information. It has not made them more risk averse, but rather it has simply made them more documentation driven.”

NO BENEFITS ASSOCIATED WITH LOW DOCS

As a good portion of brokers believe that low doc mortgages do not satisfy the NCCP requirements, many cannot see any benefits associated with writing this type of product.

However, according to MKM Capital’s Michael Watson, there are many benefits associated with writing low doc mortgages.

“Brokers writing low doc mortgages are assisting good clients obtain a loan and have a great opportunity to grow their business,” he says.

“In addition, brokers can build trusting, long-term relationships and gain repeat business with their low doc clients who will usually refinance back to mainstream banking when they are able.”

“The fact is,” Mr Savins adds, “incremental business opportunities exist. Low docs could potentially cater to 10 per cent of the market – which could equal substantial growth for a broker’s business.”