Are you using the Compliance Serviceability Calculator?
Serviceability assessments – what are the issues?
APRA has provided guidance to lenders on serviceability assessments aimed at strengthening mortgage lending standards. However, APRA’s guidelines are not enforceable or binding and how lenders apply the recommendations varies greatly from lender to lender.
What will be approved by one lender with a high income to loan ratio, will be declined by another. In addition, different structures of the same loan scenario can also provide different borrowing capacity results across the lenders.
So how should you conduct your preliminary serviceability assessment moving forward? In APRA’s view, effective servicing policies should incorporate a buffer of at least 200 basis points above the loan product ‘interest rate’. In addition, good practice should ensure the customer can service the loan by applying a minimum floor assessment of 7.00% to all the customer’s existing lending.
According to APRA, these tests will ensure that the customer could continue to afford the loan repayments in the event of a changing financial environment and takes into consideration a number of past increases in lending rates, market forecasts, as well as international benchmarks for serviceability buffers and average lending rates.
What are your obligations under NCCP?
Under the National Consumer Credit Protection Act 2009, if you are providing credit assistance then as a broker, you are required to make a preliminary assessment to determine whether the credit contract is not unsuitable for the consumer. This is based on the information obtained when making reasonable inquiries about the consumer’s financial situation, their requirements and objectives, and taking reasonable steps to verify the customer’s financial situation.
As a broker you must complete a thorough assessment to ascertain if a customer can adequately service the debt. It does not require you to strictly adhere to APRA’s guidelines. However, you do need to ensure that you are performing the preliminary serviceability assessment using your own calculator because you need to be able to justify the outcome and explain the arithmetic that was used to ascertain if a customer could adequately service the debt.
This means that a lender’s servicing calculator should not be used to complete your preliminary assessment as it will not provide justification for you under NCCP due diligence requirements. If you conduct your own preliminary assessment completely independent of the lender, then obviously it is going to have a very different outcome to the serviceability assessment completed by the lender. Therefore, unless you are able to explain the mathematics of your client’s ability to fit repayments into their life, you are not complying with the legislation.
How to adhere to your obligations
The Connective compliance calculator is included in every Borrowing Capacity Calculation, displayed at the top of the lender listing so to satisfy ASIC’s requirement that an independent servicing assessment has been carried out.
The following outlines the sequence of calculations used to determine the maximum loan amount:
- Gross Income – this is the sum of taxable, non-taxable and rental income across applicants.
- Net Income – this is gross income (2), minus income tax and the Medicare levy. The income tax is calculated using standard tax brackets, and the Medicare levy is 1.5% of gross income.
- Monthly Living Expenses – by default (derived from system matrix), however if the true and correct monthly living expenses for a customer (identified and completed within the ‘Needs Analysis’ questionnaire – Page 9 of 9) is higher than the system default, then you must enter this higher amount into your borrowing calculation.
- Surplus Monthly Income – this is simply Net Income (2) minus all expenses (Living + on-going credit commitments).
- Maximum Loan Amount – the loan amount is calculated as a function of Surplus Monthly Income, Assessment Rate, and Loan Term. This calculation simply takes the Surplus Monthly Income as a monthly repayment and extrapolates to a loan amount.
Note: The default assessment rate (since 1st March’16) is currently set at 7.25% over a 30 year term.
At the end of the day, we must always complete a preliminary serviceability assessment using the Connective compliance calculator as each lender has different credit policies and formulas for producing the customer’s borrowing capacity.
It’s unlikely that lenders will move to a standard approach for income and expenses as this would remove competition. The best practice for all brokers is to remain compliant with legislation, document income and expenditure, and finally, ensure the loan is not unsuitable and that the borrower can comfortably afford the debt with a minimal chance of going into financial hardship.
Connective – here to support you
Did you know that the compliance support team is available on Helpdesk and Chat? You can contact us by clicking the Help icon in Mercury and then selecting Compliance from the menu, or you can get in touch with us simply by emailing our Compliance Helpdesk directly at compliance@connective.com.au .Whatever compliance questions you may have, we’re here to help.