HBA is supportive of Bank Negara Malaysia’s (‘BNM’) latest announcement on Responsible Finance which was announced on 18 November 2011. It will help borrowers engage debt management in a more pro-active manner and negate the Non-Performing Loans (NPL) that haunts both borrower and lender should leaner times descend on us.
The Responsible Finance guideline requires Financial Services Provider (“FSP”) to provide assessment of individual affordability and provide suitable and responsible advice to customers on their capacity to take on additional financing. FSP will be required to undertake a comprehensive assessment on the borrowers sources of income and verify against independent sources to ensure that the applicant has the ability to repay the loans throughout the tenure of the loan is much lauded. Furthermore, the income assessment shall be based on the borrowers’ Net Income, which is gross salary less statutory deductions such as EPF contribution and tax deductions.
Net Income = Gross Salary – Statutory Deductions (including EPF and taxes)
The Responsible Finance guideline also requires the FSP to clearly disclose to the borrowers the implications of any interest rate hike on the loans they take, illustrating to them just how much more they will have to pay should the Base Lending Rate (BLR) go up.
Under the Responsible Finance guideline, borrowers will also not be penalised heavily for early settlement of their loans. Instead, FSP will only be allowed to charge for the cost incurred in processing the loan and not for profit loss from the early settlement of the loan.
HBA has been advocating this policy to be implemented for a very long time in order for FSPs to exercise prudence and good judgment when disbursing loans. Due to stiff competition and KPI targets set by the Board and Senior Management, FSPs have been too lenient and aggressive in providing financing, resulting in artificially inflated property prices with many young adults being declared bankrupt due to their inability to repay their debt obligations.
Although it remains the legal responsibility of the borrower to repay all his debt obligations, FSPs must demonstrate a higher moral obligation and not just a profit obligation to their shareholders. FSPs should not approve loans to borrowers who cannot demonstrate the ability to repay the loan. The Responsible Finance guidelines call for all FSPs to advice this group of borrowers on how to better manage their finances before applying for a loan instead of just pushing loans and hoping that they will not default.
HBA agrees with BNM that the credit assessment is based on Net Income instead of Gross Income as the Net Income. The Net Income is effectively the take-home pay that represents the income available to the borrower to settle his debt obligations as well as the cost of living. HBA further understands that FSPs have been told to disregard one-off sources of income such as annual discretionary bonus in their assessment of the Borrowers. This is to arrive at a more prudent credit assessment and HBA is supportive of such a move to achieve an orderly growth in the banking sector.
It is well known in the market that property speculators have been using ‘Rental Agreements’ as proof of income when taking up multiple mortgages. Notwithstanding the BNM Guideline on a maximum Loan-to-Value (“LTV”) of 70% for the 3rd and subsequent mortgage, it is hoped that an FSP will be more vigilant in accessing dubious income sources by property speculators when applying for multiple mortgages.
HBA applauds BNM’s move to stop FSPs from charging excessive fees for early repayment of the loans. It is timely that BNM has saw it fit to finally intervene in the battle of ‘David vs Goliath’. For far too long, borrowers who have managed to set aside enough money to settle their loans early have been penalized by their FSP under the pretext of hidden and dubious clauses in a length of Loan Agreement filled with numerous legal jargon that is beyond the understanding of a lay borrower.
Reintroduce DSR Limits
HBA calls for BNM to take additional and stronger measures in order to curb excessive property prices due to irresponsible financing and to better protect the consumer. As per mentioned above, under the Responsible Finance guidelines, FSPs are required to assess the borrower based on his Net Income instead of Gross Income. However, as part of the Responsible Finance guidelines, BNM has withdrawn its recommended guidelines of a maximum Debt Service Ratio.
The Debt Service Ratio (“DSR”) is the Debt Repayment divided by the Borrowers Income. Prior to the Responsible Finance Guidelines, the maximum DSR was set at:
1/3 of Gross Income for single loan repayments; and
1/2 of Gross Income for all loan repayments combined.
However, the exception was given to Civil servants who could borrow from the Cooperatives with a DSR of up to 60% of their Gross Income (twice the margin of financing for single loan repayments).
The main reason why BNM has withdrawn the maximum DSR guidelines is because BNM wants the FSP to exercise good judgment when approving loans and not to over-regulate the market and restrict loans.
HBA would prefer guidelines for a maximum DSR limits for the following reasons:
To set a cap as guidance for FSPs to follow.
Currently the previous guidelines on 1/3 and 1/2 has found many FSPs openly flouting the rules which lead to artificially inflated property prices and many young adults declared bankrupt due to unmanageable debt levels. With the caps removed and FSPs being free to set their own lending policies, the situation of reckless financing may get even worse.
Although HBA agrees that market forces are the best form of financial regulation¸ it has been shown that we operate in an imperfect market. Hence, if BNM believes that the removal of the DSR cap is the better way to go, BNM may need better surveillance to punish FSPs who flout the guidelines with irresponsible financing.
As general guidance for aspiring borrowers.
Prior to the Responsible Finance guidelines, most aspiring borrowers knew about the maximum DSR as it has existed for a fair period of time and well published. Aspiring house buyers could budget for a home within their means by calculating the monthly loan repayments (easily illustrated by various online calculators available at most FSP websites’) and dividing it by their own gross income and if the number is below 1/3, they know that they should qualify. Aspiring house buyers could then proceed to sign the SPA and apply for a home loan.
However with the removal of the DSR and the criteria being changed from Gross Income to Net Income, aspiring house buyers are in a twilight zone. What DSR would FSP be expected to apply as an internal policy? Would it be as simple as just changing the ratio so that the end result is the same as before?
Illustration based on following assumptions:
- Gross Income = RM3,000
- EPF Deduction at 11% of Gross Income
- No Tax deductions to simplify calculations
- 1/3 = 33.33%
Prior to Responsible Finance Guidelines
DSR = 1/3 * Gross Income = 33.33% * RM3,000 = RM1,000
Under Responsible Finance Guidelines
DSR = 37.5% * Net Income = 37.45% * (RM3,000 less RM330) = RM1,000
This illustration shows that if FSPs were to merely internally adjust the DSR ratio from 33.33% Gross Income to 37.45% Net Income, the maximum monthly loan repayments would remain the same. Surely BNM’s intention is more than merely cosmetic changes or number crunching. That said, without proper guidance from BNM, this could be the reality of the Responsible Finance Guideline as FSPs fight for market share and it is back to Business As Usual.
So how does responsible financing really work to the benefit of both the borrower and the lender? There are a few Nos that need to be incorporated in our vocabulary.
NO to 100% Financing
Under the Responsible Finance guidelines, FSPs are required to inform the borrower that the more they borrow, the more they have to repay. Hence, FSPs are required to advice the borrower not to take on too much additional financing and to live within their means. Taking this one-step further, BNM should ask FSPs to stop giving 100% home financing and financing should be capped at 90% of the selling price of the house, thus house buyers need to fork out at least 10% of the down payment to from their own pocket or EPF savings to start them off on the right footing.
With the own savings and EPF contribution, borrowers would be able to pay for the 10% downpayment and afford to pay the monthly loan repayments going forward. Borrowers will also be able to lower their monthly loan repayments and build a safety net in the event of any emergencies.
No to Excessive Fees
The illustration shows the difference in the principal amount outstanding between Rule 78 and a straight line method that most borrowers expect to owe for early settlement their HP or Personal Financing. At the end of Year-5, a borrower would expect to only owe 44% of his original principal sum under the Straight Line or Equitable Apportionment where monthly repayments are apportioned equally to settle Principal and Interest.
However, under Rule 78, where a higher portion is used to offset interest, the borrower still owes 53%. As a result, many borrowers taking longer tenures for their HP are often out of money and have to top-up when they wish to early settle their HP / Personal Financing.
Although Housing Loans are calculated differently compared to HP, a similar principle applies where a higher portion of the monthly loan repayment is applied to interest during the initial period of the Housing Loan. As a result, a buyer who has paid 4 years out of a 20 year Housing Loan would expect to owe only about 80% of the principal sum, the borrower would owe closer to 90% as this writer personally experienced.
Hence, HBA calls for BNM to intervene in order for a more equitable apportionment of interest and principal from the borrowers monthly repayments.
In closing, HBA is supportive of BNM measures to curb irresponsible financing and to better protect the consumers. However, HBA urges BNM to take additional measures as highlighted above.
NATIONAL HOUSE BUYERS ASSOCIATION [HBA]
No. 31, Level 3, Jalan Barat, Off Jalan Imbi, 55100, Kuala Lumpur
Tel: 03-2142 2225 | 012- 334 5676 | Fax: 03-22601803