The Australian Securities and Investments Commission is considering enforcement action against lenders for breaches of responsible lending laws on interest-only loans.

The regulatory crackdown follows an eight-month investigation that found many lenders were falling short of legal standards for assessing home loan applications.

Interest-only loans are typically marketed to investment borrowers in the housing market, but are also being marketed to owner-occupiers.

Borrowers do not have to repay the principal on their loans until the interest-free period expires, but then face more onerous repayment schedules.

They are more expensive than standard mortgages, in which borrowers repay the principal and interest from the outset.

ASIC’s review of 140 borrowers’ files held at the four major banks and seven other lenders found that many investors had been misled on terms for repaying loans.

Here are the main findings of the investigation:

• In 40 per cent of the customer files reviewed, the affordability calculations made by lenders assumed the borrower had longer to repay the principal on the loan than they actually did.
• In over 30 per cent of cases, there was no evidence that the lender had considered whether the interest-only loan met the borrower’s requirements.
• In over 20 per cent of cases examined by ASIC, lenders had not considered the borrower’s actual living expenses when approving the loan, but relied instead on expenditure benchmarks.

ASIC deputy chair Peter Kell said the regulator was disappointed to find that the practices of many lenders fell short of expectations.

“Interest-only loans may be a reasonable option for some borrowers,” he said.

“However, lenders must have robust processes in place for assessing a customer’s ability to afford a loan, taking into account the increased repayments once the interest-only period ends.

“They should lend responsibly, and in a way that does not result in consumers taking on debt that they cannot afford, especially if interest rates rise.”

Lenders caught out by the investigation have agreed to overhaul their lending policies under guidance from ASIC.

Perhaps the most significant reform likely to flow from the investigation will be a new requirement on lenders to limit the interest-free period to five years for owner-occupiers.

The following table shows how interest-free loans can inflate the cost of paying off a mortgage.

A borrower who takes out a loan with a 15-year interest-free period ends up paying more than $100,000 in additional interest compared to a borrower with a standard principal-and-interest mortgage.