To borrow money, you need to prove you have value in the underlying asset (can the lender sell it and recover its money?) and that you have the ability to make the loan repayments.
It’s not too much of an overstatement to say that borrowing has never been more difficult. From the more personal side, a number of Beanies have experienced push-back from lenders, so we understand the frustration.
▶ Update 11 March 2022
▶ Definitions may help!
▶ A bit of history
▶ The why
▶ The deposit
▶ The loan repayments
▶ Deposit vs loan repayments
▶ Self employed or new to business?
▶ The banks
▶ How to help yourself
Update 11 March 2022
It seems the government has been listening to borrowers and lenders! Both parties felt that the new lending rules (from 1 December 2021) were extremely restrictive. In some instances, borrowers would have approved the lending if it wasn’t for those rules.
So – the lenders are now expected only to look at future living expenses and not necessarily current or recent transactions.
We still recommend you analyse your current expenditure yourselves to see if there are savings to be made.
You should provide the bank with a detailed budget for your expenses going forward – a reasonable, detailed budget. Even though it may no longer be necessary, it may be a good idea to show them your analyse anyway. This indicates that you’ve thought about the impact of borrowing money on your current spending pattern, and also that you’ve allowed for changes in lending rates (you have, right?).
LVR = Loan to Value Ratio
It’s calculated by taking the loan amount and dividing by the purchase price of the property.
- Borrowing $950k on a $1m property has a LVR of 95% (you have a 5% deposit)
- Borrowing $800k on a $1m property has a LVR of 80% (you have a 20% deposit)
- Borrowing $450k on a $1m property has a LVR of 45% (you have a 55% deposit)
- Borrowing $150k on a $1m property has a LVR of 15% (you have an 85% deposit)
The higher the LVR, the higher the perceived risk. And – the LVR determines whether you fall into the banks’ restricted category of being a ‘risky’ prospect.
Credit Contracts and Consumer Finance Act (CCCFA)
This legislation was put in place first in 2003, so it’s been around for a while. Its main purpose is to protect consumers from entering into credit agreements (primarily loans) without being fully informed of the pros and cons.
There have been a number of amendments and this has been done via Credit Contracts Legislation Amendment Act (multiple years). The talking point these days, is the CCCLAA (2021).
Reserve Bank of New Zealand (RBNZ)
RBNZ is independent of the Government and is responsible, amongst other things, is to monitor registered banks and issue currency. It is where registered banks (NZ and international) deposit excess money (and receive interest). Registered banks also borrow from RBNZ and are charged interest.
When we hear in the news that RBNZ has raised the Official Cash Rate (OCR), it means it has increased the interest rate they charge other banks. These banks pass on the increase to its customers.
Responsible Lending Code
This was referenced in the CCCFA by the Ministry of Business, Innovation and Employment (MBIE), and came into force in June 2015. It’s a code of conduct for banks lending money and sets out their responsibilities to borrowers.
The revisions in February 2021 which came into force in December 2021 require lenders to more fully document their decision-making process when lending.
Failing to do so could result in individual penalties of $200k and/or a penalty of $600k to the bank – this is now included in the revised Code.
Global Financial Crisis
In the early 2000’s, the global housing market was booming – prices were increasing with no end in sight…until late 2007-08, when the US housing market collapsed, resulting in the Global Financial Crisis (GFC).
The GFC was the culmination of many failings within the US mortgage market. Some of them are outlined below. However, it’s important to note that these shortcomings were not present at the time within the NZ mortgage market.
- Very low (teaser) interest rates which increased significantly after the teaser period ended*
- Those with poor credit histories could still borrow
- Little, if no, security on the loan
- No proper assessment of the borrower’s ability to pay
- Insufficient regulation
As a result, NZ was not impacted as greatly as the US, Europe, and much of the rest of the world.
After the dust settled, stricter regulations were put in place by most central banks in the world – US Federal Reserve, European Central Bank, Bank of England included. The Reserve Bank of New Zealand followed suit.
* We see this from credit card companies which offer a 0% interest upon transferring a credit card balance – the rate increases significantly later.
Loan-to-value ratio (LVR)
From 2012, NZ house prices were rapidly increasing, particularly in Auckland. Interest rates were low. Fearing a mini-GFC in NZ, the Reserve Bank introduced LVRs to banks, restricting them from having ‘risky’ loans on their books.
The ‘riskiness’ of a loan is partially dependent on the amount borrowed compared to the value of the property.
The LVR is calculated by taking the loan amount and dividing it by the property value. The higher the LVR, the higher the perceived risk. And – the LVR determines whether you fall into the banks’ restricted category of being a ‘risky’ prospect.
- Amendments to the Credit Contracts and Consumer Finance Act (CCCFA) which came into effect 1 December 2021
- A revised Responsible Lending Code* (the Code) issued by the Ministry of Business, Innovation and Employment (MBIE) which, for the most part, applies from the same date
- Loan-to-value (LTV) restrictions imposed by the Reserve Bank of New Zealand, which can vary from time to time
The primary purpose of the CCCFA is to protect the interest of consumers in connection with credit contracts, consumer leases and land buy-back transactions. It includes a section on the Responsible Lending Code. The Code provides guidance (best practice) in following the legislation. While not legally binding, if lenders comply with the Code, it counts as evidence that they have followed the CCCFA.
The CCCFA in itself has been in place since 2003 and the lenders’ responsibilities outlined in section 9C of the Act haven’t actually materially changed. However, prior to 1 December 2021, the bank had some discretion when deciding if you can afford the loan. The revised Code now aims at quantifying that discretion. This isn’t easy – it’s trying to explain a ‘gut feeling’.
Never-the-less, the Commerce Commission’s revised Code requires detailed record-keeping about the lenders’ decision-making processes. The flow diagram below is included at page 25 of the revised 102-page Code. We’re unable to make it large enough to be readable in this format, but it goes someway in showing the minimal steps required by the lender when considering your loan application.
The revised Code also requires the following:
- Annual returns from the bank to the Commerce Commission containing information about the banks’ loan books
- How the lender tests that the loan is suitable for you, and whether you can afford the repayments
- New certification regime for lenders, where the Commerce Commission must be satisfied that the banks’ current and prospective managers are ‘fit and proper persons to hold their respective positions’.
- Formalised procedures in place which, when followed, meet the requirements of the CCCFA – consider this the ‘tick-the-boxes’ exercise.
We salute its intention is to save borrowers from finance companies known for charging high interest rates on short-term, pay-day loans. However, it seems to have resulted in lending institutions (mainly banks) being micro-managed, and doesn’t give enough credit (no pun intended) to the majority of consumers who are realistic in what they can comfortably afford.
* Pages 18-23 would be the most relevant for (future) home-owners.
First up – getting a loan approved is going to take time. Much more than what was required in the past.
From our experience, loan approval now takes more than four weeks…and that’s if you’re organised.
Gone are the days where you could put an offer on a property, subject to obtaining finance within two weeks. Without having pre-approval, it’s not going to happen, your offer will lapse, and you’ll need to start the search again.
And – if you do have pre-approval, take notice of how long it applies and regularly touch base with your bank to make sure it’s still in place.
And – make sure your pre-approval covers the property you intend to buy. One of our Beanies had pre-approval for a property going to auction. When that didn’t work out, re-pre-approval for a different property auction was needed.
Your accountants will usually need four to six weeks to prepare your financial statements. Beany offers an ‘urgent’ service where, starting from an extra $295 plus GST, we can provide a turn-around of ten working days after we receive everything we need from you.
Please note that preparing financial statements other than at year end will incur an extra cost. Beany will provide you with a quote before we start work, so you can be sure of the fee.
Banks are restricted by the Reserve Bank in how much they can lend, and the easiest way to monitor this is by looking at your deposit. Let’s say one bank has $1,000,000,000 (one billion dollars) to lend to home buyers and investors. The Reserve Bank’s restricts their lending as follows:
- A maximum of $100m (10% of total lending) to owner-occupiers who have a deposit less than 20%.
- A maximum of $50m (5% of total lending) to property investors who have less than 40% deposit.
At the 2021 average market rate, $150m wouldn’t even pay for 150 properties. It’s a small pot.
The remaining $850,000,000 is available to those who have a deposit of 20% or more.
- New-builds – there are no rules around the deposit amount or percentage.
- Kāinga Ora First Home Loan Scheme – a deposit of 5% could be sufficient for a loan on a first home
- Short-term bridging loans
- Refinancing for the same or lower amount is exempt
- Remediation – usually bringing the house to meet current building codes
So that’s just the first step – do you have an adequate deposit? If yes, the next step is for banks to scrutinise your expenditure.
So, you think you can make the loan repayments? Think again. Most of the blame for the increase in scrutiny has been placed on changes to the CCCFA. In fact, as mentioned above, it’s the largely down to revised Responsible Lending Code.
There are a number of online calculators estimating how much you can afford, but these have been rendered almost useless by the level of information banks now require before granting approval.
Your bank statements for up to nine months will be inspected. In detail. Before handing them over to the bank, we suggest you do some self-analysis, and be brutally honest with yourself.
Prepare a summary of your past expenditure* and outline how you plan to reduce certain costs once you have a mortgage in place. Presenting a weekly or monthly budget will help, but only if it’s realistic. Allow a ‘buffer’ for unexpected expenditure and/or an increase in interest rates.
* This is actually a very good exercise to carry out regularly. You may be paying for subscriptions you’re no longer using; your interest expense could be reduced if you arranged an overdraft facility; you may be paying bank fees on an account you’re no longer using.
This author actually had automatic payments going to a phone company weekly instead of monthly, and from two bank accounts. When finally noticed, I had overpaid by $1,300. The refund was nice, but it demonstrates that the checking exercise would have brought this to my attention a lot sooner!
Many assume that if you have a high deposit, borrowing money against the property will be straight-forward. It is…to a point.
The banks’ income comes from you paying interest on the loan. If you’re unable to make the loan repayments, they will have the option of selling your home to repay the debt.
- You may not be in default if you miss one payment, or even two. By the time it takes the bank to realise there’s a problem, they’ve already missed out on several months of interest income.
- They’ll issue formal default notices and meet with you to see if there are other options for you to make payments.
- Once out of options, they will sell the house. This also takes time and banks aren’t in the real estate business.
Banks don’t make money from selling homes; they rely on the steady stream of interest which is included in their forecasts and budgets.
For those with no fixed income, obtaining a loan has always been challenging. You’re unlikely to have a long track record of steady income, which makes it difficult to prove you can afford the loan repayments.
With these recent changes, it’s certainly not going to get any easier. At the very least, you’ll likely need financial statements for the past two tax years, and a realistic business forecast. This is in addition to going through your personal finances.
You may also have business loans or other borrowings which need to be disclosed. Have you budgeted for their repayment? Are they secured over assets the bank will need as security?
We suggest your accounting system be accurate and kept up-to-date. If your accountant is already preparing your GST returns, any errors are likely to have been picked up and adjusted prior to finalising the return.
The lending process may not even stop at you. If you have guarantors (usually parents), the bank needs to look into their finances as well, and quite possibly to the same level as they do with you.
- Could they afford the payments if you defaulted?
- What other borrowings and properties do the guarantors have?
Banks aren’t thrilled about the new requirements. They want to lend money. For most, their business model was working well before LVRs, the recent changes to the CCCFA, and the revised Responsible Lending Code. They assessed their own risk levels and had discretion on lending. They are accountable to their shareholders who receive dividends from their profits – risky lending and losses aren’t acceptable.
The measures implemented are aimed at preventing possible future events, even though such events haven’t been widespread in the past (in New Zealand).
It was announced in January 2022 that the Commerce Commission has ordered an inquiry as to whether banks have over-reacted to these new lending laws.
Mainstream banks are not the only lending institutions subject to the CCCFA and Responsible Lending Code. Think short-term, pay-day loans, vehicle financing, and the financing of other assets.
Being generally smaller than the major banks, it’ll be difficult for them to absorb the additional costs associated with these changes. Who will pay for them? The consumer.
Borrowing is tough. To give yourself the best outcome, we recommend one or more of the following:
- Think well in advance
- Anticipate the questions from the lender and have the responses prepared
- Speak to mortgage brokers – they have contacts in multiple lending institutions (not just banks) and usually receive commission fees from the lender (not you) upon securing a loan
- Speak to your current bank
- Keep your personal and business records up to date
- Prepare a personal budget, and for your business (if needed)
Have a chat with your accountant about preparing financial statements (it doesn’t need to be done only at year-end) – the time it takes and what you need to provide. Please note that preparing financial statements other than at year end will incur an extra cost. Beany will provide you with a quote before we start work, so you can be sure of the fee.
You can provide the bank with reports directly from your accounting system, but lenders prefer financial statements – this means an accountant has checked how you’ve recorded transactions and the financial statements are in accordance with tax (and other) legislation.