The Importance of Loan Purpose

Every home loan written in Australia is governed by Federal legislation that demands lenders to adopt responsible lending practices. In essence this simply means that the bank should not grant approval to an applicant who cannot demonstrate a capacity to repay the loan. Further than this it needs to be clear that the applicant will benefit from the loan being approved.

Whilst these two conditions might seem like common sense and easy to understand, there is a technical side that you should be aware of so that you can be sure the bank is doing the right thing for you.

National credit legislation which came into effect on 1 July 2010 provides that lenders should be careful not to recommend products which are unsuitable for the borrower. The key words are ‘not unsuitable’. For a loan to be unsuitable it would have to mean that the borrower could not reasonably be expected to make the repayments on the loan facility without suffering financial difficulty or hardship.

That's why it's important for banks to be rigorous in their assessment processes to ensure that borrower’s capacity to repay a loan is clearly established. To do this they will be asked to provide proof of income from a variety of sources including payslips, PAYG summaries, Australian Taxation Office assessment notices and BAS statements if necessary.

In some instances copies of transaction account statements will also be required to confirm the deposit of salaries into the borrower's bank account.

An essential part of the home loan application process occurs when a signature is required indicating the purpose of the loan. The answer to this question triggers the legislation which will cover the loan and, in essence, if the loan is declared to be for a predominantly business or investment purpose, the borrower will lose the protection of the national credit legislation. That is because legislation provides protection for borrowers who are looking for a loan to effect a personal purchase, for example a home, not an investment property.

If a self-employed applicant applies for a business loan, then this falls outside the ambit of legislation and the protection of the national credit rules do not apply.

What are the rules for loan purpose?

The loan will be protected by the legislation if it is predominantly for personal purposes. In a practical sense this means more than 50% of the loan amount should be used for personal purposes.

If the applicant declares that the credit to be provided is to be applied wholly or predominantly for business purposes, or investment purposes, other than investment in residential property or for both purposes, then the loan will be declared as an investment purpose which will for outside of the protection provided by the National Credit Code.

What protection is provided by the national credit code?

The national credit code provides protection for consumers especially in cases where the products provided by the lender are later deemed to be unsuitable. This means that where a lender grants credit product to a borrower that the borrower later feels is not affordable or inappropriate than the borrower can have his case investigated by an independent authority, usually the Credit Ombudsman or the Banking Ombudsman as appropriate.

If either of the ombudsman investigations agrees that the lender has been mistaken or reckless in the performance of their duties as a responsible lender then the mortgage contract can be declared null and void and basically, the borrower can walk away from his or her loan agreement.

Naturally, lenders are keen to avoid this situation and will take steps to determine what the purpose of the loan is before granting full approval. Investors however do not necessarily have the protection of the National Credit Code so they should be careful before signing any loan documentation to make sure they understand the full implications of what the loan requires.

In most cases however, banks treat every application in exactly the same manner whether The National Credit Code applies or not. This is because banks are keen to be seen as responsible corporate citizens and do not want to recommend or suggest any product that a customer could eventually take issue with. But when the chips are down they can rely on the legislation to relieve them of responsibility.

Solicitors are on the lookout for inappropriate contracts and products and usually suggest to their clients that they exercise caution when applying for any loan. Some investors think it appropriate to obtain a copy of possible mortgage contract in advance of applying for a loan.

Getting a copy of the loan contract beforehand gives investors the opportunity to have their solicitors cast their eye over the details to ensure that there are no hidden stings in the tail.

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