Before you enter a credit contract

 

Before entering into a credit contract (e.g. a home loan), a credit provider (e.g. a bank) must disclose certain facts to the borrower.

Responsible lending obligations: suitability

Credit providers, credit assistance providers and lease providers are obliged to assess the suitability of a credit product before providing it to a consumer (ch 3 National Consumer Credit Protection Act 2009 (Cth) (“NCCPA”)).

Below we detail the law that applies to credit providers, however it is worth noting that separate provisions of the NCCPA apply in relation to:

credit assistance providers;

lease providers,

short-term and small amount credit contracts (pt 3-2C NCCPA);

reverse mortgages (pt 3-2D NCCPA).

For more information (seePayday loans” in Mortgages, credit cards and other finance products).

Making an assessment of unsuitability: credit providers

A credit provider must assess whether a credit contract will be unsuitable for a consumer not more than 90 days prior to entering or increasing the credit limit under that contract (s 128 NCCPA). That period is extended to 120 days where the credit is secured credit used to purchase residential property (s 26 National Consumer Credit Protection Regulations 2010 (Cth) (“NCCP Regulations”)).

In making that assessment, section 130 of the NCCPA requires a lender to:

a make reasonable enquiries about the consumer’s requirements and objectives in relation to the credit contract;

b make reasonable enquiries about the consumer’s financial situation; and

c take reasonable steps to verify the consumer’s financial situation.

What constitutes reasonable enquires was considered in Australian Securities and Investments Commission v Cash Store Pty Ltd (in liquidation) [2014] FCA 926 (26 August 2014), the first reported case considering a credit provider’s responsible lending obligations. In the case, the court stated that, “assessing whether there is a real chance of a person being able to comply with their financial obligations under the contract requires, at the very least, a sufficient understanding of the person’s income and expenditure”. Therefore, inquiries about a consumer’s current income and living expenses ought be undertaken by all credit providers.

ASIC’s Regulatory Guide 209 “Credit licensing: Responsible lending conduct” also makes clear that the use of “benchmarks”, such as the Henderson Poverty Index, to estimate a consumer’s income or expenditure “is not a replacement for making inquiries about a particular consumer’s current income and expenses, nor a replacement for an assessment based on that consumer’s verified income and expenses”.

As to the extent further inquiries or verification are necessary, ASIC’s Regulatory Guide 209 advises that this will vary depending upon the circumstances. Relevant factors will include:

the potential impact upon the consumer of entering into an unsuitable credit contract;

the complexity of the credit contract;

the capacity of the consumer to understand the credit contract; and

whether the consumer is an existing customer of a credit provider or a new customer.

In relation to assessing a consumer’s “objectives or requirements”, in ASIC v The Cash Store Pty Limited, ASIC argued that for loans up to $500, simply listing the purpose of the loan as “personal” or “living expenses” was inadequate information upon which to make an assessment of whether the contract was unsuitable, however “bills” was sufficient. Justice Davies accepted this and found that the following descriptions were sufficient to enable The Cash Store to make an assessment about whether the loan was unsuitable for the consumers purpose:

“food” for a loan of $214.95;

“doctor, insulin” for a loan of $164.95; and

“work shoes” for a loan of $257.

Further information in relation to responsible lending can be found in:

Financial Ombudsman Service “Approach to Responsible Lending” and Circular Issue 5; and

Credit and Investments Ombudsman Position Statement 5 “Responsible Lending”.

When will a credit contract be unsuitable?

Under section 131 of the NCCPA, a lender must assess that a credit contract will be unsuitable for a consumer if it is likely that, at the time of the assessment:

a the consumer will be unable to comply with the consumer’s financial obligations under the contract, or could only comply with substantial hardship; or

b the contract will not meet the consumer’s requirements or objectives.

Substantial hardship is not defined in the NCCPA, however:

a presumption of substantial hardship will apply if a consumer could only comply with their financial obligations under the contract by selling their principal place of residence (s 141(3) NCCPA), unless the contrary is proved. This provision directly targets the practice of “equity-stripping” and asset-based lending by predatory lenders;

ASIC’s Regulatory Guide 209 “Credit licensing: Responsible lending conduct” provides guidance to credit providers when assessing “substantial hardship”.

A lender is prohibited from entering into or increasing a credit limit under a credit contract that is unsuitable (s 133 NCCPA). Subsections 133(2) and (3) – which replicate the relevant provisions of section 131 – provide guidance about when a credit contract will be unsuitable.

A credit provider’s failure to meet these responsible lending obligations will give an affected consumer a right to seek compensation under section 178 of the NCCPA.

Providing the consumer the assessment of unsuitability

Section 132 of the NCCPA requires a lender to provide to a consumer, upon request, a written copy of the assessment:

where the request is made prior to entering a credit contract or increasing a credit limit, prior to entering a credit contract or increasing a credit limit;

where the request is made within two years of entering a credit contract or increasing a credit limit, within seven business days of the request;

where the request is made more than two years but less than seven years after entering a credit contract or increasing a credit limit, within 21 business days of the request.

A lender is prohibited from requesting or demanding payment for providing a copy of the assessment (s 132(4) NCCPA).

If a lender does not provide credit to the consumer, the lender is not obligated to provide the consumer with the unsuitability assessment. However, the Credit Reporting Privacy Code may provide a consumer with some access to reasons for refusal.

Commencement of the obligation to assess unsuitability

The obligation relating to the suitability of credit contracts and leases commenced for most licensees on 1 July 2010. However, some large licensees (i.e. Australian Deposit Taking Institutions, like Banks, and registrable corporations) required more time to implement compliance systems. Accordingly, for these lenders:

if the application for credit or lease was received between 1 October 2010 and 31 December 2010, the obligations commenced on 1 April 2011;

if the application for credit or lease was received on or after 1 January 2011, the obligations commenced on 1 January 2011 (r 24A NCCP Regulations).