Lenders beware: borrowers may not have to pay
Jonathan Teh - Articled Clerk
As rising interest rates
stretch borrowers to their limits, lenders need to be wary
of borrowers with no income to repay a loan secured over
their only residence.
Between 1996 and 2006,
the New South Wales courts have refused to allow lenders to
enforce a mortgage in such circumstances. There is a real
risk that these secured loans are set aside, leaving lenders
exposed to unsecured loans where the borrower need not
repay.
A mortgage
can be set aside for two reasons:
1 it
may be unjust to lend money to a borrower if the
lender knew they would have no income to repay the loan; or
2 it may be
against good
conscience for the lender to take advantage of a
borrower (with no income to repay the loan) by granting the
loan and then selling their only residence.
In Victoria,
the first reason could be adopted by the Victorian Civil and
Administrative Tribunal for loans regulated by the Consumer
Credit Code. Section 70 allows that Tribunal to reopen
unjust transactions, and to vary or discharge the mortgage.
A Victorian
court could adopt the second reason for any loan, including
investment loans. The court’s power is based in equity: an
unconscionable transaction can be set aside if the borrower
was under a serious or special disadvantage, and the lender
took advantage of that disadvantage: Commercial Bank of
Australia Ltd v Amadio (1983) 151 CLR 447.
NSW courts
have criticised lenders who are content to lend on the value
of the security. In Elkofairi v Permanent Trustee Co Ltd
[2002] NSWCA 413, Mrs Elkofairi’s loan application
showed that she was retired with no income. In Mrs
Elkofairi’s circumstances, this placed her in a special
position of disadvantage. The lender must have known that
the only source of repayment was to sell her only residence.
In this case, the lender had unconscionably taken advantage
of Mrs Elkofairi.
A loan might
be unjust even if a borrower or their broker falsely
overstates their income. In Perpetual Trustee Co Ltd v
Khoshaba [2006] NSWCA 41, the broker falsely stated Mr
Khoshaba’s income, even though he was a retired pensioner.
However, the lender failed to inquire what the loan would be
used for. This indifference showed that the lender was
willing to lend on the value of the security alone.
Therefore, the mortgage was unjust, and was partially set
aside.
To protect
against these outcomes, lenders need to proceed cautiously
if a potential borrower:
-
has no
income, are retired or has stated income that is suspect
or unusually high;
-
has
provided their principal residence as security; and
-
does not
own any other property.
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