Treasury has released a discussion draft of a regulation to ban exit fees.
Submissions can be made until 1 March 2011.
The proposal goes much further than just banning exit fees on home loans payable on early repayment. Instead, it bans any fee payable at the end of a loan contract other than fixed rate break costs and discharge administration fees. It also applies to residential investment loans.
The introduction of exit fees in 1996 saw increased competition, reduced interest rates, product development, and increased access to finance for Australian consumers. Those benefits have been dramatically demonstrated by the resilience of the Australian housing market and Australian mortgage backed bonds throughout the GFC. This good work will be undone out of a misguided and ill informed initiative designed to help consumers, but which will have the opposite effect.
Industry commentators have raised many issues with the proposal, including the following.
- Reduces competition by making lending uneconomic for existing and new lenders. Lending is uneconomic if early repayment occurs without exit fees. Prepayment risk is too great for smaller lenders to take. Big players can savage small lenders' books (and significantly disadvantage consumers) by offering low rates to gain market share and then increase rates once the competition has been crippled.
- Makes borrowing harder, particularly for first home buyers and those with small deposits (because costs previously carried by lenders will need to be charged upfront), thus making housing even less affordable. Incongruously, the initiative permits establishment fees while banning deferred establishment fees which benefit borrowers by lowering upfront costs and remove a cost completely for borrowers who do not repay early.
- Leads borrowers to inappropriately refinance when there is no real benefit. The widely acknowledged inability of comparison rates to provide a benchmark between loan products demonstrates clearly that product comparison is difficult and sophisticated art.
- Increases borrowing costs for consumers as many lenders will now need to charge regular account fees, establishment fees, and other fees – being fees that are never payable where exit fees apply to recoup these costs from borrowers who elect to repay early.
- Reduces household savings by encouraging some borrowers (arguably the most vulnerable) to refinance to tap into any newly gained equity in their home, resulting in the double whammy that the loan term will generally start again, for say another 30 years, and the amount of debt increased. Given early years of a loan are primarily only covering interest this can result in no principal reductions for many years.
- Favours large balance sheet lenders in particular the large banks who can amortise prepayment risk over a large portfolio and fund working capital, and correspondingly disadvantage smaller lenders and securitisation programs.
- Betrays the user pays principle, because those borrowers who switch regularly will be supported by borrowers who do not.
- Imposes additional regulation where no economic or social benefit has been demonstrated and there has been no Regulation Impact Statement.
- Sends 'warning signals' to overseas investors that Australia intends to over-regulate and is not a good place in which to invest.
- Extends an initiative to all lenders which initially was stated to apply only to banks (is it intended to extend the ban beyond banks?).
- Reduces product design flexibility (eg capitalising LMI, establishment costs, honeymoon rates, shared equity appreciation loans etc).
- Increases the impact of prepayment risk on Australian issued mortgage backed securities, thereby increasing overall interest rates for all borrowers.
Consumers are already adequately protected
Protection for consumers significantly changed on 1 July 2010 with the commencement of the NCCP Act. It is important to allow time to see the effect of that substantial change before introducing more regulation, unless a need is clearly made out – which is not the case with the proposal to ban exit fees.
Arguably, such a substantial change to the law should be the subject of an amending act considered by both houses of parliament. Making this significant change by regulation does not give consumers the chance for their elected representatives to vote on the issue.
If the ban on exit fees proceeds
There are a large number of fees and charges which are properly payable at the time a loan is finalised which do not fall within the generally accepted meaning of 'exit fee'. If the regulation proceeds, it is important that it is amended to exclude the following fees:
- mortgage discharge administration fees (existing exemption);
- break costs on fixed rate lending (existing exemption);
- fees payable other than on early repayment by borrowers, for example at the end of the term of a loan (the extension of the ban to fees payable at any termination is outside the intention of the initiative which was limited to early repayment);
- fees payable for housing affordability home loans that do not have traditional interest rates, such as fees payable under 'shared equity' mortgages provided by a number of lenders;
- where the borrower had the option at the time of entering the credit contract of choosing a loan with or without an exit fee (provided by the same lender);
- cost recoupment fees (LMI, valuation, loan establishment, document preparation) where the lender has paid or absorbed these costs on behalf of the borrower (which can represent a significant saving for borrowers at a time when they need it most);
- annual fees, line fees, account keeping fees for the period ending on the repayment date (ie broken period);
- honeymoon (discount) rate recovery fees;
- fees for repayment within 24 months of loan settlement (to at least discourage complete rorting of the ban on exit fees by borrowers, and reflecting that it is unreasonable for a borrower to repay a 30 year loan within two years);
- fees approved by ASIC (to allow for unforseen consequences and permit product development);
- fees disclosed in a way prescribed by the regulations (we envisage here a specified prominent disclosure); and
- interest equalisation fees, where a lender has agreed to provide a lower interest rate so long as the borrower remains with the lender for a specified period.
For more information, please contact:
t +61 2 9931 4927
t +61 2 9931 4753
t +61 2 9931 4810
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.