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FOS GUIDELINES IN LENDING - LOW DOC LOANS

Posted by on in Reserve Bank of Australia
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Financial Ombudsman Service Circularlssue 5 - March 2011

 

When investigating a dispute about a low doc loan, we consider the following matters:

* Did the client fully understand the process, so that it can be said that a conscious decision has been made?

* Have clear questions been asked of the client in assessing the relevant and available information?

* Have the monthly repayments been accurately calculated and disclosed at the time of application?

* Was legal or financial advice recommended and/or required?

* Did the FSP engage in good industry practice by exercising the care and skill of a diligent and prudent lender in:

a) selecting and applying credit assessment methods; and *b) forming an opinion about the client's ability to repay?

Was there lnformatlon in the appllcatlon which should have led a reasonable and prudent lender to make further inquirles, but the FSP chose not to?

" Did the FSP act prudently by assessing the entire transaction contemplated by the client to see if there is capacity to repay from proven sources?

 

And finally, it is important to be aware that an acknowledgment by the client that the client does not rely on the FSP's assessment of capacity to repay may not excuse the FSP if it fails to make a proper assessment.

 

Whether an FSP has made reasonable inquiries about a client's financial situation turns on whether information has been obtained to make this assessment.

 

Reasonable lnqulrles

Therefore FOS takes the view the reasonable lnqulrles an FSP ought to make in order to assess a client's financial situation include enquiring into:

* the client's gross and disposable income * the reliability of the client's income.

 

2. Reasonable steps to verlfy a client's financial situation

When assessing whether an FSP took reasonable steps to verify a client's financial situation, FOS will have regard to:

* the normal business practices of a prudent margin lender, and * the verification practices applied in other credit areas.

The legislation requires FSPs to take reasonable steps to verify the client's financial situation (sectlon 985G(2)).

 Verification of income and reliability of income

Examples of the type of information an FSP may need to provide to FOS about its verification of income and reliability of income include:

* where the client is a PAYG employee: * payslips

* confirmation of employment, and " recent income tax returns /group certificates;

* where the client is self-employed: * recent income tax returns * a statement from the client's accountant, and * business activity statements

Verificatlon of credit worthiness

FOS may ask an FSP to establish its verification of the creditworthiness of the client. A credit check is considered to be an action undertaken by a prudent lender in the normal course of its business.

3. Aseesslng whether the faclllty will be unsultable Documenting inquiries, verification and assessment

FOS may ask FSPs to provide:

* information about the inquiries made * documents evidencing the inquiries made * information about verification procedures * documents evidencing the verification procedures undertaken, and * documents reflecting the assessment of unsuitability made.

 

FOS expects FSPs to establish that:

* thelr Inquiries about the cllent's financial situation were reasonable * the lnformatlon about the client's financial situation was verified, and

* an assessment was made that the margin loan was not unsuitable by providing documents that record and reflect:

" the inquiries process * the inquiries made into the client's financial situation * the verification process * the verificatlon process that was followed and * the assessment of unsuitability.

An absence of these documents to establlsh that lnqulrles were made and verlfied and an assessment was made that the facility was not unsuitable will affect an FSP's abllity to satisfy FOS that the FSP met the Conduct Obligations.

 

CASE HISTORY

The loan Mr and Mrs Z applied for a loan from the financial service provider (FSP) to:

* obtain additionalfinance of approximately $200,000 to assist them in purchasing another property.

The FSP approved their loan based on:

* their income as disclosed in their application, and * their declaration that the loan was within their ability and capacity to service.

Mr and Mrs Z disclosed:

* partnership income of $400,000  rental income of $40,000, and * a parenting allowance of $20,000.

The FSP dld not make any independent enquiries to verify this information.  

Mr and Mrs Z subsequently claimed that the FSP's decision to lend amounted to maladministration as they did not have the capacity to service the additional loan of $200,000.

 

FOS investigation

The case manager considered a prudent and diligent lender ought to have been alerted to make further enquiries when presented with a Low Doc income declaratlon listing:

* pre-tax income of $440,000 and " a parenting allowance of $20,000.

The level of income was, on the face of it, inconsistent with an entitlement to a parenting allowance of $20,000.

The case manager obtained from Mr and Mrs Z a copy of their partnership tax return prepared one month prior to their loan application. The tax return revealed a net partnership income of $45,000.

The case manager also found that Mr and Mrs Z had:

* made two previous loan applications in which they had made similar income declarations (although these loans had not proceeded), and

* two opportunities to correct their misquoted income, and failed to do so. FOS assessment

As the FSP had failed to make enquiries, the case manager concluded that the FSP's approval of the loan was maladministration in lending.

However, the case manager also took into account:

* the Ombudsman's criteria of fairness in the circumstances of the case, and

* section 12GF (18) of the ASIC Act which deals with proportionate liability in claims of misleading conduct.

ln light of these principles, the case manager did not consider that the FSP should be liable for Mr and Mrs Z's loss in its entirety.

The case manager concluded that Mr and Mrs Z should bear two thirds of their loss and the FSP was responsible for one third of the Ioss.

FSP response The FSP rejected the case manager's conclusions, and said:

* it had met its guidelines for low doc lending, and was entitled to rely on Mr and Mrs Z's income declaration, and

borrowers who are unable to provide more traditional evidence of their income.

 

However a customer's self-declaration of financial details will not protect the FSP from having the loan considered maladminlstration or unjust if the circumstances were such that the FSP ought to have made enquiries but chose not to do so;

 

6. Relying on the comments of the trial judge in Permanent Mortgages Pty Ltd v Cook [2006] NSWSC 1104, a customer's false declaration, whether knowingly or inadvertently, is a relative factor to be taken into account, but is not decisive, such that the FSP should avoid liability for maladministration in lending;

 lf the FSP had adopted good lndustry practice and sought clariflcatlon, any reasonable lnqulry would have revealed that Mr and Mrs Z dld

7. ln thls case, the FSP was prlvy to financial lnformation lnconsistant wlth the customers earnlng $40,000, namely that they were also receiving parenting allowance.

 

* the approach had serious consequences for low doc lending for the industry and was contrary to the acceptance of low doc lending by the Australian Prudential Regulatory Authority ("APRA").

The Ombudsman agreed with the case manager's assessment. ln his decision, the Ombudsman noted the following:

1. APRA has a supervisory role in the Australian financial market. Complying with APRA's requirements does not provide a protection to an FSP in relation to whether or not it has engaged in maladministration in lending,

2. A lender's obligation to lend responsibly is encapsulated in * the common law; * to the extent the loan is regulated, section 70(2Xl) of the Uniform Consumer

Credit Code (.UCCC') (and now section 76(2Xl) of the National Credit Code); * for subscribing FSPs, clause 25.1 of the Code of Banking Practice ("CBP");

and

* section 12DA of the ASIC Act;

3. The UCCC does not, of itself, prevent low doc lending. However, the common  law and the CBP requlre an FSP to exercise the care and sklll of a dillgent and prudent lender, and arguably a dlllgent and prudent lenderwould not rely solely on lnformatlon provlded by the customer to a loan;

 

4. The fact that an FSP has entered into a low doc loan is not sufficient to establish maladministration. However, lt ls a known risk of low doc lendlng, and

 the risk iassumed by the LENDER.

 

The case manager agreed that there had

been maladmlnistration in lending, and that apportionment of liability as suggested by the case manager was appropriate.

 
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Comments

  • doyla66
    doyla66 Tuesday, 28 August 2012

    One property I have in question has an interesting twist - bank valuation was only $880k of house and land and the loans that I was given for that house and land equal $911k !! The valuation was done at the time the second loan was being processed...I have the documents to show it already. Bank need not to provide any of it..

  • doyla66
    doyla66 Tuesday, 28 August 2012

    Impressive LVR, JJ - how did they work that one out?

  • doyla66
    doyla66 Tuesday, 28 August 2012

    Basically over two loans (that still exist today) One is a residential loan and the other a business loan. The land is secured against itself and then it is used again as security in the business loan to build the house on the same land. Basically the land loan was borrowed twice!

  • doyla66
    doyla66 Wednesday, 29 August 2012

    Oh dear! Good luck with that, JJ!

    I had a related situation: line of credit, private lender, second mortgage over two properties registered despite agreement within family company that it not be registered - ratbag lawyers interfered. Bullied (no exaggeration) by other company director, preventing my getting out of any of the loans until second mortgage was resolved, second mortgagee solicitors forced me to sell one property, LVR problems caused by their delaying tactics, no capital gains or positive ROI after all my work, and halved my limited income. Complete ripoff by lawyers manipulating original loan deal to make money for themselves and major shareholders/directors of the company, which was then liquidated.
    And they wondered why I wasn't happy with the outcome!
    They're on my 'LIST' - NSW Law Commission dispute resolution possible and re-examination of all legal processes. Watching statute of limitations carefully. Lawyers stalling tactics cost me repeatedly and very unfairly. What they did would not be lawful now.
    Ever noticed how solicitors don't like taking on other solicitors?
    And when solicitors recommend another solicitor to handle work interstate they choose someone who won't give the original solicitor any problems?
    I was naive and trusting then - not any more!

  • doyla66
    doyla66 Thursday, 30 August 2012

    Actually, I too noticed the reticence expressed by lawyers about taking on another even when they know the difference between right & wrong. When you watch their faces for the wimpy little embarrased half-smile, you end up thinking - what a wuss! I am paying you my money for this half-baked crap! That is part of the reason why I have the opinion I do of the WA Law Society - it is more about protecting their own bums on the boards than doing what is right for the client or about their 'friendships' in business. :p

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