Based on the reasonable inquiries about the consumer and any other relevant information available, a preliminary assessment must be made on whether the proposed credit contract is ‘not unsuitable’ for the consumer.
The proposed credit contract will be assessed as unsuitable, if at the time of the preliminary assessment it is likely that:
- the consumer would be unable to meet their financial obligations or could only comply with substantial hardship
- the contract does not meet the consumer’s requirements of objectives.
ASIC have stated that to demonstrate credit assistance providers are complying with their responsible lending obligations they should have in place adequate processes to assess that the consumer has the capacity to repay the credit contract without substantial hardship and that the contract meets the consumer’s requirements and objectives.
Assessing the consumer’s capacity to repay
Based on the inquiries made about the consumer’s financial situation and the steps taken to verify this information, a decision will then need to be made if the consumer has the capacity to repay the loan. The maximum amount that will be repaid under the contract, including any fees must also be considered.
The following factors must be considered in making this decision:
- the amount of remaining disposable income the consumer has after living expenses have been deducted from after-tax income
- other debt obligations, child support
- if this level of disposable income leaves them in a vulnerable position, for example if there was a rise in interest rates
- if the consumer’s expenses are higher than on average, e.g. because they live in a remote area
- consistency and reliability of the consumer’s income
- if the consumer would be forced to sell assets to repay the loan
Generally the National Consumer Credit Protection Act 2009 (National Credit Act) presumes that a consumer should be able to meet the financial obligations of the credit contract from their income, not equity in an asset. Reverse mortgages and bridging loans may be exceptions to this position.
The following examples have been provided by ASIC to illustrating their guidance on capacity to repay and substantial hardship.
Regular family expenses
A credit licensee may use a system that estimates realistic family living expenses required to meet the consumer’s (and their dependants’) living costs to assist in assessing if a credit contract may cause a consumer substantial hardship.
The consumer would need to be able to meet these living costs from their income, after deducting the ongoing repayments under the credit contract (and all other repayments and regular financial commitments of the consumer).
If the consumer was under this level, the licensee would as a policy, not consider the consumer to have the capacity to repay the loan without substantial hardship, regardless of their circumstances.
Temporary period without income
A consumer decides to undertake tertiary study with the aim that it will lead to a future promotion and seeks credit to pay for the course. Their employer has given assurances that the consumer will be able to take their job back at the end of the course, if they do not obtain a higher paid one within the firm on the basis of the new qualification.
For the duration of the course the consumer can only meet their repayments under the proposed credit contract by making serious cutbacks on their expenditure. They have indicated they are willing to do this in the short-term for the purpose of improving their long-term prospects and they have a realistic plan for economising so that they can still meet their minimum loan repayments.
In this case, the credit licensee may conclude that the consumer would have the capacity to repay without substantial hardship, even if most other individuals (with a different purpose for the loan funds) would not.
Where a consumer cannot currently comply with their existing financial obligations under a credit contract (or only with substantial hardship), a credit licensee can refinance the consumer’s debts if, after refinancing, they will be able to comply with the resulting credit contract without substantial hardship.
In such circumstances, the level at which substantial hardship is assessed may well be different from a situation where the consumer was not previously having serious repayment difficulties.
A casual employee receives their first fortnightly pay cheque and applies for a credit card.
It is not appropriate to multiply their salary by 26 to calculate their annual income, because the consumer’s employment is on a casual basis and their salary may fluctuate.
If a products involve a large ‘balloon’ payment at the end of the loan term must, the credit licensee must assess if the consumer can meet both the regular repayments under the loan and the final, much larger balloon payment.
ASIC expect the credit licensee to be satisfied that the consumer understands, and has the capacity to cover, the final repayment before offering this type of product to the consumer.
Assessing if the credit contract meets the consumer’s requirements and objectives
A credit contract will be unsuitable if it does not meet the consumer’s requirements and objectives. The credit assistance provider must therefore determine the consumer’s requirements and objectives and where there is any uncertainty this must be resolved through the reasonable inquiries process.
Some examples of factors that could be taken into account to assess that a credit contract is not unsuitable include:
- the consumer’s stated objectives in obtaining the credit and the nature of the credit requested by the consumer
- where the loan is to purchase a specific asset, the loan term and the expected useful life of the asset
- interest rates and fees
- how complex is the credit contract and if a more basic product would meet the consumer’s needs
- any balloon payments
- if the consumer is switching loans, the benefit of the new credit contract to the consumer.
If none of the credit contracts that you provide credit assistance for meet the requirements and objectives of the consumer you must not enter into a contract with the consumer, suggest a credit contract to the consumer or assist the consumer to apply for a credit contract.
The following examples have been provided by ASIC to illustrating their guidance on meeting a consumer’s requirements and objectives.
Key features for the customer
If a consumer indicates that the ability to refinance their home loan is a key requirement, a credit contract that has high exit fees or other break costs would not meet the consumer’s requirements and objectives.
A consumer contacts a mortgage broker by phone because they are having short-term difficulties in meeting bills, pending the maturing of a term deposit.
In this circumstance it would not be appropriate to suggest a loan secured by the equity in the consumer’s house as the establishment costs would not be warranted given the consumer’s financial difficulty is clearly short term.
A preferable approach might be to suggest that the consumer investigate the penalties associated with early access to the term deposit.
Additional considerations for switching and refinancing
Additional analysis is required where a credit assistance provider engages in switching and refinancing activities.
This will include considering whether the new credit contract will result in an overall cost saving to the consumer that is likely to override any loss of benefits or the cost savings may be minimal however the new credit contract better meets the consumer’s requirements and objectives.
Refinancing where a consumer is in arrears
A higher level of inquiries will be required where the consumer is refinancing because they are having trouble meeting their repayments or they may be in arrears on their existing contract.
Where a new credit contract will have the same repayments, it will be possible to determine that on face value it will be unsuitable.
Should the current contract be assessed as ‘not unsuitable’ and no alternative contract is considered ‘not unsuitable’, the credit assistance provider can suggest the consumer remain in the current contract without contravention of the responsible lending obligations.