Future of Mortgage Lending in Australia : Risk Profiling and Pricing

Hi Ben Kingsley here, I just want to talk to you about what’s going to be the future of mortgage lending here in Australia. Now, before we talk about the future, let’s think about what happened in the past. In the past, we used to see mortgages that are like this. We had standard variable rates, and those standard variable rates were the main rates that were available in the marketplace. From that, we’ve got a product called a basic rate and that basic rate was a discount to that variable but it didn’t have all the features and benefits that you’re looking for in a fully fledged standard variable loan.

So from that point in time, we saw the banks produce products called “Pro-packs”, they are Professional Packages and what actually happen to these Pro-Packs is that they offer different kind of features and benefits. Now the Pro-Packs started to offer discount pricing so you get 0.7 off the standard variable rate when you bought that product. They also have things like offset account etc etc. Now, that’s all good, credit card is another one that they used to have as my pen starts to fail me. Anyway, this is how it went. In terms of prior to people like Aussie Home Loans and competition and mortgage brokers coming into the market, we also used to have a variance between owner occupied and investment lending so they used to be a slightly higher increase in the interest rate compared to what the owner occupier or private purchaser were paying. So that’s now come back to roost because we’ve just seen APRA introduced higher pricing to try and slow down investment lending. Now, what’s going to happen here or what we are seeing in terms of competition in the marketplace is that they has been a lot of discounting happening on this Pro-Packs and the majority of clients have these type of Pro-Packs. So the more you borrow, let’s say we are borrowing greater than $250,000, we would start to get a discount so call it .7 in the old terms. Then if we borrow greater than $500,000, we would get a bigger discount, maybe .85! If we borrow more than $1mil, we would get a discount of 1%. Now, that’s what basically happened in the past. All of the lenders are now doing this and we are seeing competition in this space and its not uncommon to see 1.2% to 1.4% basis points off these variable rates. The more you borrow, they would give the discount. Now, that then says that everyone on the BBQ is going, “Well, I’ve got a .8 discount and I’ve got a .9 discount”. What does it all mean? Well, depending on what rate you’re paying, it’s a discount off that level. Everyone is now enjoying these discounts but how is that going to benefit the banks in keeping their margins at the level that they want to keep them? Now, part of this process is about, ok, how do we do that? Well, with the advent of innovation and technology and big data, the banks are now going to be more powerful in being able to price what we call personal risk profiling and pricing.

Now this personal risk profiling and pricing, will give the banks the ability to price based on a lot of different variables so the complexity around what interest rates you are going to pay into the future is going to be determined by some of these things, all of these things or a combination of these and even further, credit risk profiling that the banks may undertake. So, more than ever, we’re going to see some complexity around these types of pricing.

We’re not going to see the one size fits all pricing that we see in the past, we’re actually going to see banks and lenders price in this manner.

Let’s work through them because it’s really important. And given that it is probably going to be around 18 months to 24 months before we see this pricing takes shape, it is good to get your house in order now before they start doing these type of pricing.

So, we are going to see things like credit score being more and more important. Now, credit score is the way in which you pay your credit back, the way you conduct yourself around that so it talks about your overall score, your history and also your credit activity. Now, I’ve used this word “churn” here. What churn means is, is you are refinancing from one lender to another lender every two or three years, either because your broker is doing it or it’s because you think you need to get a cheaper interest rate, well guess what. The banks are seeing this on your credit profile and they are saying, “We don’t necessarily want a customer who keeps refinancing to us and away from us and who’s so price conscious that they are not going to be a valued customer which we can make a profit for our shareholders on.” So the more activity around refinancing you do, potentially the higher interest rate that you may pay in the future.

In addition to that, they are going to look at the security. What is backing up the mortgage that they are lending against and more and more detail is going into the postcode or location in terms of is that a good location, is there lots of volatility in prices in that location ie. mining towns or areas that have oversupply potential such as city locations – CBDs. What type of properties are you going to buy? Student accommodations, studio apartments, high risk type properties or units. So there could be pricing based on the type of properties that it is as oppose to just looking at it as just a residential property. In addition to that, the purpose ie. purpose built. So is it for holiday letting? Is it for overnight stay such as serviced apartments? Is it student accommodation? What is the general purpose of that property and again, you could see higher pricing introduced for what they would consider higher risk purposes to what is going to happen to that property.

Now, we’ve already seen loan to value ratios taking shape. The higher the loan to value ratio, we already starting to see some pricing around those loan to value ratios because from the banks points of view, they packaged up those securities and they get their funding against those when they go to the Reserve Bank or when they go and price that book of security so that they can borrow more money to lend out and keep their margin at a profitable level. So we’ll see the lower loan to value ratios potentially, the better price point.

And then we are going to talk about into employment. Now this is some areas, look, we see consistency of employment being important but not necessarily focused in. So the industry that you work on, or work in I should say, are there any qualifications that you may have and the level of income that you are earning, all can be combined into an algorithm that would spit out a pricing point.

Again, gone are the days where a mortgage broker can go to a bank and say, I’ve got 60 clients. Can you give all these 60 clients a better deal based on the amount that they are borrowing as opposed to based on their individual circumstances.

So, get ready for it. It is absolutely coming. We are already seeing it in the personal lending space but it is going to come into mortgages, I suspect over the next 18 months to 36 months, we are going to see more of this types of pricing.

What is that message for anyone looking to lend?

Well, it’s going to be more confusing than even the most complex mobile phone deal that are out there in the marketplace. So again, more importantly than ever, you need to work with a qualified property mortgage broker. They are the best of the breed, they are going to be able to sort through this. The retail pricing that you see advertised will mean nothing. These brokers would be able to identify and sort through all these thousands of different combination to try and work out where your price point sits. So, technology and innovation is going to disturb the way mortgages are going to be written in the future. So it is really important that you understand these. Get your house in order. Understand these stuff first. You need to make sure you are great in managing your money. You need to make sure your conduct, your activity history, all of those things are being well looked after. Otherwise, you can potentially paying more for your mortgage rates. In terms of the types of property you are going to be buying whether it is for owner occupier or for an investment, again, it is going to be really important. What sort of risk level does the banks have in regards to how much debt you are taking on. You may also see in the future that lenders won’t have an appetite for lots and lots of lending with one consumer where you might have $1.5 mil with one lender which in the past used to give you a great discount may not be the case into the future. I suspect the banks would want that type of money from really qualified individuals on high income in professional jobs but if it’s a mom and dad teacher and nurse, and they are trying to borrow $1.5 mil to build up their property portfolio, I suspect you are going to see pricing for their household to be different from that of a professional household. Disappointing, I understand it but at the end of the day, this is commeriskrce. This is business and from the bank’s point of view, they want safe risk and with that risk they are going to price it accordingly. So the higher the risk, the higher the cost it is for you as a borrower.