Academic journal article Journal of Politics and Law

Economic Cost Provisions in Fixed-Rate Home Loan Contracts and Breaches of Australian Consumer Law

Academic journal article Journal of Politics and Law

Economic Cost Provisions in Fixed-Rate Home Loan Contracts and Breaches of Australian Consumer Law

Article excerpt

Abstract

Fixed-rate home loan contracts in Australia usually include a clause in terms of which the financial institution providing the loan can recover what is variously called an 'economic cost' or an 'early repayment adjustment' if the borrower repays the loan before the fixed term ends, in circumstances where bank funding costs have declined. In their calculation of such costs, financial institutions rely on movements in the Australian Bank Bill Swap Rate (BBSW) as an indicator of funding costs. However, market data indicates that the BBSW is an inaccurate measure of actual funding costs and that the BBSW can in fact decline when funding costs have increased. Furthermore, it can occur that the rates at which a financial institution is lending money for home loans can exceed the rate being paid by a borrower who is paying their loan early, with the consequence that the financial institution has an opportunity to mitigate its loss by re-lending the funds that have been repaid. Yet such mitigation is not taken into account by financial institutions in calculating economic costs. The result is that banks recover more than their actual losses when loans are repaid early. This breaches both the common law and Australian statutory consumer law. The article urges that the corporate regulator, the Australian Securities and Investment Commission, investigate such practices and if bring a test case on behalf of consumers to have such practices declared unlawful.

Keywords: consumer law, banking, mortgages, loans, fixed-rate, contract, penalties

1. Introduction

A class action which commenced in 2010 in which litigants challenged the validity of a range of bank fees has focussed attention on the rights of bank customers under consumer law. In the action (which, at the time of writing, is on-going), bank customers have challenged the validity of a number of fees, collectively known as 'exception fees', including fees where accounts were overdrawn or where credit card limits were exceeded. The challenge was based on the argument on that in so far as such fees bore no relation to the actual processing costs occasioned to the banks by overdraws or limit excesses, they constituted penalties, and were therefore unenforceable. In Andrews v Australia and New Zealand Banking Group Ltd, (Note 1) the High Court unanimously held that a fee could amount to un unenforceable penalty even in the absence of a breach of contract by the party upon whom it was imposed. The case has now been remitted to the Federal Court for a determination of whether the fees in question did in fact amount to penalties.

This article considers a different type of imposition to which a particular class of bank customers is subject, namely the charges imposed on customers who have fixed-rate home loans when the loan is paid out before the fixed-rate period has expired. Given that many home loans in Australia have a fixed-term component, liability for such charges impacts on a large group of consumers. The argument made in this paper is that the charges imposed on consumers constitute unlawful penalties for two reasons: First, because the calculation used by banks to determine economic costs bears no necessary relation to actual losses, and second, because the banks fail to take into account the mitigation of loss that they could achieve in certain market conditions by re-lending funds that have been repaid early.

Part 2 of this article discusses the concept of economic costs as they relate to fixed-rate home loans, using standard form contractual terms from major Australian banks as examples. Part 3 discusses the way in which banks calculate economic costs and examines whether the method used is consistent with consumer law. Part 4 discusses the circumstance when a bank is able to re-lend money at a higher rate than it was charging on a fixed-term loan that has been repaid, and argues that prejudice is suffered by customers because of the failure of banks to take into account the mitigation of their losses that they could achieve by re-lending the funds. …

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