The home had four bedrooms upstairs, two with ensuites. Photo: The home had four bedrooms upstairs, two with ensuites. Photo:
Money Finance News What really decides whether you can afford a mortgage Updated:

What really decides whether you can afford a mortgage

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Spare a thought for Justice Nye Perram of the Federal Court. He tried to introduce a little colour and humour into the generally boring business of a legal judgment, only to have sanctimonious souls attack him for being “out of touch” with reality.

Justice Perram’s “crime” (in the eyes of some) was to use an exaggerated example of how people might economise in order to service a mortgage, how their discretionary spending could change once they had to meet a big commitment to the bank each month.

“I may eat wagyu beef every day washed down with the finest shiraz but, if I really want my new home, I can make do on much more modest fare,” said His Honour last month while deciding for Westpac and against the Australian Securities and Investments Commission (ASIC) on a legal question of what Westpac should consider before responsibly giving someone a loan.

The worthy folk of the Consumer Action Law Centre and Financial Rights Legal Centre were outraged. Cardigans were flapped, Birkenstocks stamped.

“To suggest that borrowers ditch wagyu steaks and shiraz for cheaper food really is out of touch with the realities faced by most Australians,” CALC chief Executive Gerard Brody told any media who wanted to know.

“The decision suggests that banks do not have to have regard to people’s actual expenses when they lend – which in turn will allow lenders to continue to extend unsustainable loans which set people up to fail,” said FRLC chief executive Karen Cox.

Bank-bashing remains one of our favourite sports, elevated to Olympic status by the Hayne royal commission. Banks were shown to indeed deserve a good thrashing over a number of issues.

Some executive heads have rolled, the pick of the Australian non-executive directors club were proven to be useless, and the formerly toothless watch-puppies were encouraged to do more than yap – which has on-going repercussions. Even the federal government says it will embrace most of Kenneth Hayne’s recommendations, after furiously resisting the royal commission for years.

But there’s a danger that the bank-bashing momentum is going too far if we start expecting banks to take all the responsibility for loans and the borrowers none.

Not being able to get a loan can be worse than suffering “mortgage stress”.

There have been and always will be shonks, spivs, spruikers, conmen and conwomen who talk people into making bad financial decisions, into borrowing to make bad investments. The Storm Financial scandal remains the prime example of bad advice matched with reckless bank lending to create appalling hardship.

There also are people who make bad financial decisions all by themselves, and others who are simply unlucky when circumstances turn against them.

When a loan goes bad, it’s a delicate business trying to work out where responsibility resides. The pendulum has swung so far now that it seems everyone wants to blame the bank for granting the loan and not the borrower for taking it on.

Taking out a loan is a risk. There’s no guarantee that any investment won’t turn bad, or that misfortune won’t befall the borrower.

What the Hayne royal commission and Reserve Bank data show is that the vast majority of loans are responsibly serviced. Only around 1.5 per cent of loans are 30 days in arrears – historically, not a bad figure. And that’s just arrears, not in default.

What most commonly causes serious problems with a mortgage isn’t the size of the loan, whether the borrower wants to continue eating wagyu and drinking Grange, or falling property values – it’s the stuff beyond the lender’s ability to forecast.

Divorce, unemployment, serious sickness – they’re the things that most commonly send mortgages bad. The geographical pockets of dud loans in Australia match areas that have had rising unemployment. It’s why arrears are higher in Western Australia.

Source: PeterWargent.com

Contrary to common opinion, banks rarely make money out of failed loans. The idea that banks “set people up to fail” doesn’t make financial sense.

The problem clearly exposed by the royal commission was when a sales-and-bonus culture within a bank encouraged individuals to push lending to or beyond the limit, when brokers or employees had personal upside but no responsibility for the eventual outcome. 

Occasionally, vulnerable people are indeed led astray. One of my favourite examples of that came out of a Senate banking inquiry – Westpac gave a 98-year-old woman a 30-year mortgage for a dodgy Gold Coast property punt.

The royal commission has achieved its purpose in exposing abuses, and ASIC and APRA have been emboldened to actually do their jobs. Banks are being much more careful to lend “responsibly”.

Justice Perram’s ASIC v Westpac case was about an old war – it was a historical case about how Westpac used to measure the ability of borrowers to repay a loan – not how it now does.

There are people, some of them prominent in the media, who would like banks to be much more miserable when it comes to lending money. I suspect such people have no knowledge of what it was like trying to get a loan back in the days when banks were very tight indeed, using a formula of only lending a multiple of how much cash had been held on deposit.

That tended to disadvantage people on the margin, people trying to get a start on the property ladder, while the well-off had no difficulties at all. The danger now is that we could repeat that scenario.

A key reason the previous RBA governor, Glenn Stevens, was wary of imposing macro-prudential lending restraints was that, if not careful, they would primarily disadvantage first-home buyers. The Law of Unintended Consequences is always working.

As it turned out, investors were the prime target as APRA tightened lending standards, letting more first-home buyers back into the game.

For anyone applying for a loan, what the bank is prepared to lend is obviously important, but some self-knowledge and personal responsibility should play an equal role.

The real estate advice I was given by a friend when I first came to Sydney decades ago from the much-cheaper north was that, if you want to live in the expensive city, you have to be prepared to bite off a bit more than you can chew and then chew like mad.

There’s a risk in that. It is sometimes far from easy. But wagyu is over-rated anyway.