The GFC has much to answer for. While it is widely acknowledged that the Australian economy rebounded strongly and ultimately fared far better than the USA and European markets, the repercussions are still being felt. Particularly hard hit were Aussie SMEs, the majority of whom made it through the worst of the financial crisis only to find they had stretched themselves to the end of their means with nothing left.
Reliant on funding that the overly cautious banks refused to provide to businesses that couldn’t provide up-to-date tax returns to verify income, these are the businesses that have since lost their way, falling by the proverbial wayside, casualties of our unpredictable and uncontrollable global economy.
One solution to their financial woes that would have been open to these businesses in the past is securing a so-called ‘low-doc’ or Low Documentation Loan. Low-doc is type of lending where the borrower may not have their tax returns available, so instead provides alternative income verification for the loan.
A once thriving market in Australia, low-doc lending has reduced dramatically over the last three years. This is primarily due to tightening credit guidelines, especially around refinancing and debt consolidation.
The situation has also been exacerbated by the fact that a vast number of specialist non-bank lenders that would have been prepared to write these loans when banks would not, are no longer around (e.g. Bluestone, GE Money) following the GFC. It was a turbulent time for the market and very few specialist lenders remained unscathed.
Yet one positive that small business owners looking to securing funding can take from this is that those remaining specialist lenders are tried and tested, experienced practitioners with a deep understanding of the market. Whereas before there was a risk of cowboys, today we are in much safer hands.
Getting business finance
Despite the reduction in low-doc loans, there is still a significant demand for this type of lending from the growing number of small business owners and the self-employed. Business finance is not getting any easier to obtain. Low-doc loans are crucial for these borrowers, often providing them with a single lifeline and allowing them to access funds to expand their businesses and pay down expensive business loans. These borrowers are the backbone of the Australian economy: tradies, hairdressers and other service providers; Aussie battlers that deserve support. On the most part, low-doc lending is still very much a grey area and the lack of knowledge around it breeds caution and confusion.
Over the last year or so the issues outlined above had tainted low-doc lending to the point where we were unsure whether there was a future for low-doc loans. However a significant turning point has since led to the safeguarding of consumers and I believe secured low-doc as a viable and safe form of lending.
National Consumer Credit Protection Act
On 1 July 2011, the National Consumer Credit Protection Act (NCCP) was passed. This was the result of comprehensive discussion and negotiation between state and federal governments over several years finally culminating in bringing together all the different states and territories into one nationally consistent framework to legislate the way in which credit is regulated.
This framework clearly lays out the new requirements for all credit providers in relation to how they can deal with a consumer, meaning there’s now a greater level of consumer protection.
The immediate benefit for borrowers is that the NCCP makes things simpler for all Australians to know their rights and what they can expect when arranging any form of credit. It also means a lender cannot make a loan unless they have complied with the responsible lending provision.
This new provision means a loan will now have to pass a ‘not unsuitable’ test, which has been designed to eliminate shonky lending practices often performed by fringe lenders or lenders of last resort who provide unsuitable levels of credit to borrowers who are not in a clear position to manage repayments.
In addition to that, new compulsory licensing requirements for all credit providers as part of the NCCP are also set to weed out these same lenders whose behaviour has not only unraveled the dreams of borrowers in the past, but also brought a very unnecessary element of disrepute to the industry.
So therefore under the NCCP requirements, brokers and lenders now have to evidence the borrower’s ability to repay their loan without undue hardship. This makes low-doc loans exponentially safer. Instead of requiring tax returns, verification is done through evidencing income via alternative means, for example BAS statements, business banking statements, or an accountant’s letter. The demand for low-doc loans is as great as it has ever been and the difference is that there is now clarity around what is appropriate alternative income verification.
Small business owners seeking funding are now presented with an exciting opportunity and should discuss their options with a broker who understands the credit criteria of the lenders operating in this space. These brokers will be able to place a low-doc loan with the right lender each time and the loan will proceed smoothly.
Rising confidence in low-doc
At present, one barrier to the growth of low-doc loans is market confidence that has declined for the reasons outlined above. Those lenders who have survived intact from the GFC have proved that they have sustainable business models and are here long-term to support the industry. I am confident that time will improve confidence levels in these loans, especially once responsible lending is fully integrated into brokers business models.
Looking to the future, low-doc lending is an area where non-banks are likely to emerge in strong competition to the banks. Specialist lenders have a deep understanding of the self-employed and small business market and have designed products specifically for this type of customer. These lenders will play a leading role in providing finance to the self-employed and small businesses.
Non-banks, being generally smaller and more localised, have the ability to individually assess each loan rather than pushing it through a credit-scoring model. Low-doc loans have performed well in Australia in the past and will continue to do so in the future, especially with more stringent guidelines now attached.
It seems inevitable that the self-employed and SME markets will continue to grow. To ensure these businesses can access essential funding in this way, it is essential to be aware of the opportunity and have a clear understanding of the new landscape; with confidence we are now on much safer ground than before.
We also need brokers and non-bank lenders to embrace the opportunities available to them within this underserviced market. For them, by gaining a clear understanding of how these loans work, brokers are also very likely to be rewarded for their efforts through higher commissions paid to them. Everyone is a winner! Alternative income verification loans are the way of the future.