Recently Home Loan lending rules have been in the news due to a number of various reasons. From the ASIC case against Wespac that got dismissed last August to the Royal Banking Commission it’s been discussed a number of times. But what are lending rules for and why have they been changing?
What Are Home Loan Lending Rules?
To begin with let’s figure out what they are exactly. Fortunately unlike a lot of things in finance, it’s actually quite simple. Imagine if a random guy on the street walked up to you and wanted to borrow $500,000.
You’re a multi-millionaire who loves making money and so you are more than happy to investigate whether or not this could be a good deal for you. You can lend him the $500,000 and he’ll agree to pay it back over time with interest. A win / win.
But how would you know that this complete stranger would actually stay honest to his word and pay you back all your precious money? Maybe he’s flat broke and will just run off? He could only work 1 day a week and thus, not earn much money at all meaning he might never be able to pay you back. All these possible reasons are why lending rules exist.
They are rules that the bank follows in order to determine whether or not you’re trust worthy enough and actually capable of paying back their precious money over 30 years.
Lending Rule Examples
An example of a lending rule you’re no doubt familiar with is the home loan deposit. Here the bank is making sure you’re serious by demanding you put a large amount of your own money at stake first. That way you’re less likely to run off or open 1,000 loans with 1,000 different banks all at the same time.
Other rules are things like proving you have a steady, consistent income that’s also capable of paying back the loan. You’re not going to be able to convince a bank to give you $100,000,000 when you only make $50,000 a year!
Learn the best way to save that deposit for you first home
Read the Guide!
Then there’s other rules like when banks ask for information on your expenses. Some banks like Westpac have been using automatic calculations to do this but recently many have also been demanding actual bank transaction logs in order to go through your purchases with a fine tooth comb.
Again, the aim is to protect the money they’re lending as someone might have a huge, $500,000 yearly income and look like a fantastic borrower… but then turn out to be a huge risk if they’re constantly spending $1,000,000 every year on expenses.
Why Do They Keep Changing
As you can imagine, lending out millions of dollars constantly can be a very risky business if you’re not careful. As technologies change, banks are getting more and more insight into a persons financial situation more easily.
With a mostly cashless society now in Australia, simply downloading the last 3 months of bank transactions can tell you a huge amount about someone. It’s easy to see if they’re a binge drinker with a huge gambling problem or someone who saves all their pennies.
They can even see your salary coming in, savings accounts you might have and together with other profiling paint a super accurate picture of how risky you might be.
While this does kind of sound quite intrusive and a violation of your privacy, it can also provide benefits too. The more they know about their customers, the more accurate they can predict whether or not they’re going to run off with their money.
This in turn means they can reduce their overhead costs (losses from people defrauding them) and hopefully pass those savings onto you in the form of cheaper rates.
Of course, there is still a balance between demanding so much information people are uncomfortable and not having enough information to make an accurate prediction. But they seem to be treading carefully at least for now.
Other Benefits Too
On top of hopefully reducing fees, lending rules have another very serious benefit as well. This is that if done properly, it makes the banks balance sheets stronger and less likely to completely fail in a big downturn.
If they don’t screen people well and just hand out money to whomever, eventually they will have so many customers defrauding them or simply defaulting on their loan due to not being able to make payments that it will actually threaten the banks business itself, maybe even bankrupting them.
If we’re talking about a huge, “big four” bank here that will have massive repercussions for every Australian as the share prices go to zero, current loans are all called in immediately and other nasty stuff. We’ve already seen this play out in America during the GFC.
As such, while Home Loan Lending Rules might seem like a huge PITA when you’re getting your mortgage, they are very, very important! Banks shouldn’t be crossing the line or anything, but they do need to double check and confirm that you’re capable of earning enough income and are responsible enough to make your loan payments before lending you hundreds of thousands of dollars.
So have you just gotten a loan? What bank was it with and what lending rules or tests did they put you through? Let us know in the comments below!
The benefits include: 1) How to pay off your mortgage faster than 99% of people with one hour a month of work 2) How to get rid of your debt and have the freedom to spend money on the things you love, guilt free 3) Clear outline of how to setup your expenses, mortgage and general finance 4) How offset accounts work and how to get the same result without being gouged by the big banks 5) How to cut through the crap and focus on the things that truly matter when taking down a mortgage 6) How to adjust the strategy so it works for you, even if you have kids, even if you only have one income 7) How to do all of these things and maintain a normal social life (and never be cheap).