Home loan fears

How much safer is a bank loan compared to one sourced from a non-bank? The answer may surprise you.

If you've got a home loan with a non-bank, you've had plenty to smile about. With the average standard variable rate around 0.5 percent pa cheaper than what the major banks charge and probably no account-keeping fees, you've saved over $1300 in interest and fees on a $250,000 loan — and that's just in the first year.

But things don't look too cheap for non-bank-financed home owners today. When news of the US mortgage crisis hit in August, touting non-banks as most vulnerable, the question of the safety of a non-bank financial institution was raised for the first time.

Some non-banks, but not all, have been able to offer low-cost mortgages by borrowing cheaply out of the US. If there's a credit squeeze there, you can bet our non-banks will find it harder and more expensive to fund mortgages so they can on-sell back here.

For the 780,000 odd home owners who happen to bank with a non-bank, word was out that to offset these higher costs rates could rise, regardless of official rate movements. The other 1.8 million home owners who are with a bank were considered fairly safe.

The logic was that banks fund their home loans through their big retail deposit books — the cash we stash with them — rather than rely on offshore investors to fund their operations here. But as chief executive officer of the Mortgage and Finance Association of Australia (MFAA) Phil Naylor points out, "this is not entirely true. Australian banks also rely on external funding for their loans, as deposits are insufficient to cover the level of loans. So depending on the degree of exposure to wholesale funding markets, all lenders [bank and non-bank] will be impacted by the pricing in credit markets."

Two months on, who's been hit?
For home owners with RAMS (a non-bank lender that sources around 40 percent of the funding for its loans from the US market), the disclosure to the Australian Stock Exchange that its profit could be "materially" affected by the global lending crisis hit investors more than home owners. Call it bad luck or just bad timing, but RAMS listed on the ASX just weeks before the US mortgage crisis hit our shores. Investors who paid the $2.50 issue price are still a long way under, around 70 percent at a closing price of about 70 cents.

RAMS home owners, on the other hand, are still better off than if they were with a major bank. Despite some of its low-documentation loans increasing by 0.3 percent pa, the majority of its loans didn't increase by more than the official August rate rise of 0.25 percent pa.

But non-bank lender Bluestone, which specialises in low-documentation loans, was forced to raise mortgage rates by a little more — up to 0.44 percent pa on some of its mortgages. "There lies the problem," says Resi's head of consumer advocacy Lisa Montgomery. "What do you define as a non-bank lender? Twelve years ago it was easy to pinpoint what a non-bank lender was, but these days everybody who's not a bank, whether they are prime lenders or sub-prime, gets classed as a non-bank."

Commonwealth's executive general manager for retail products Michael Cant says that because banks don't rely on any one source of funding (and depending on the size of their deposit book), they are less exposed to global market interest rates from securitisation. "Many non-bank lenders and some regional banks are not in this position and are heavily reliant on global funding," he says.

But not all non-bank lenders are the same. Wizard, for example, is better positioned than most to avoid the challenges now facing some of the non-bank lenders. Wizard Home Loans chairman and founder Mark Bouris explains: "One intrinsic difference between Wizard and other non-bank lenders is that we don't source our funds via the capital markets using securitisation. Instead we fund off the balance sheet of one of the few AAA-rated companies in the world, General Electric."

But non-bank home owners shouldn't panic. Andrew Willink of Cannex says. "At the end of the day, if the lender opts out of the market, it will sell its business to another lender and existing clients will simply be transferred to the new owner, in which case it may be under a new set of terms and conditions. If a financial institution goes bust, an investor will lose more than a borrower. As long as you make your payment, you will be safe."

If you're considering refinancing to a better deal, just remember that non-banks generally charge considerably higher exit fees. Factor this cost in when doing your sums.

Low-doc home loan customers of Adelaide Bank can vouch that it's not just non-bank home loan customers who are feeling the pinch of a global credit squeeze. With around half of its funding coming from wholesale markets, Adelaide Bank was the first traditional bank to lift rates further than the official cash rate increase — by 0.25 percent on its low-doc loans, on top of the 0.25 percent August rate rise. Citibank has also increased some of its low-doc loans by more than the official August rate rise.

You can understand why some banks may be quietly hoping that higher funding costs will see the end of non-banks — get the competition out so they can rule the roost again. But as Montgomery says: "Non-banks have been largely responsible for interest rates being at the relatively low level they currently are. Do we really want to get rid of them?"

And while some banks argue that non-banks should be regulated, Montgomery reassures her clients that non-banks are regulated by the Uniform Consumer Credit Code, state fair trading and consumer protection and ASIC consumer protection provisions the same way as banks are.

The facts are simple: if this global credit squeeze continues for a significant time, home owners will see further rate rises whether they're with a bank or a non-bank. Smaller non-banks will definitely feel the pinch first.

For the complete story see Money Magazine's October 2007 issue. Subscribe now.