‘Liar loans’ are a major threat to the stability of households

Due to increasingly strained affordability, many aspiring homeowners are tempted to stretch the truth to secure a mortgage on their dream property. However, this practice could have devastating consequences, says Maria Yanotti, lecturer of economics and finance at the Tasmanian School of Business & Economics.

“Recent news reports have alerted borrowers to the dangers of ‘liar loans’, based on the findings of a new UBS research study,” Yanotti said. “In the United States, where many loan applications have been approved without any information on the borrower’s income and assets - these liar loans have been implicated as one of the reasons for the global financial crisis.”

The UBS study showed that one-third of borrowers hadn’t been “completely factual and accurate” on their loan applications.

“[The study further estimates] that there is roughly US$500 billion (A$657.95 billion) worth of factually inaccurate mortgages on banks’ books in Australia,” Yanotti said. “This is worrying, because it could mean that borrowers are taking on bigger debts than they can actually afford, falling into financial stress or even losing their homes.”

To prevent a similar mortgage crisis from occurring in Australia, Yanotti said both banks and borrowers need to practice due diligence. “Research finds that mortgage features (for example fixed or adjustable rates, maturity, loan-to-value ratio, and so on) help borrowers select mortgage products that are affordable and safer for them, with the guidance of mortgage lenders and brokers,” she said.

Lenders should also ensure that borrowers have the financial capacity to repay their loans out of their income or by selling assets under plausible conditions without having to rely “on the value of the collateral”.

“Mortgage risks often relate to mismatches between the products used by households and their financial capabilities and ability to bear risks,” Yanotti said. “For that reason, mortgage product characteristics should be monitored carefully both by banks and borrowers.”

By requiring transparency, reinforcing consumer protections, and focusing on financial education, sound lending and borrowing practices are upheld.