Low-doc home loans are designed for small business owners and sole traders who cannot provide full paperwork, such as tax returns, to pass a bank's standard serviceability checks. These loans often carry higher interest rates than traditional mortgages, and recent rate hikes have increased pressure on borrowers already paying a premium.
"When the RBA tightens the screws on mortgages, the pressure on low-doc borrowers tends to increase even further as they're usually already paying a premium on their interest rate," said Sally Tindall, data insights director at Canstar. "If cash flow then tightens on the back of a cut down in consumer spending, those low-doc borrowers who don't have a decent buffer can quickly find themselves with zero breathing room."
According to Canstar research, one non-bank lender offers an advertised low-doc rate starting at about 7% for borrowers with 45% equity, climbing to as high as about 12.29% for those with smaller deposits.
Low-doc loans make up only about 0.1% of all mortgages among banks, but Tindall noted that this figure does not capture the volume of low-doc loans in the broader market, where non-bank lenders are major originators.
Erin Kitson, an analyst at S&P Global Ratings, said low-doc loans are more vulnerable to arrears because the borrowers are often self-employed. "The cashflows of these borrowers are more exposed to deteriorating economic conditions, including rising interest rates, given the more direct impact it has on their income," she said. She added that the declining number of low-doc loans outstanding means arrears spikes appear more pronounced in percentage terms.
Some mortgage brokers challenged the perception that low-doc loans are inherently riskier. Theo Chambers, chief executive of Shore Financial, said higher rates and economic conditions could be the real cause of rising arrears. "In reality, many are successful self-employed individuals and business owners with strong assets, substantial equity and healthy cash flow, but whose income doesn't always fit the traditional assessment model," he said.
Anthony Landahl, managing director at Equilibria Finance, said all the main banks have strong offers for self-employed borrowers, while low-doc loans are mainly provided by second-tier lenders. "And there is a bit of a misconception around low-doc loans that they're more risky. But we don't find that they're more risky by their nature," he said, adding that lending standards remain strong.
Despite the uptick in low-doc arrears, mortgage arrears overall remain low, supported by a strong labour market and savings buffers. Kitson noted that higher interest rates have yet to fully show up in arrears data due to a lag, and that rising cost-of-living pressures are not yet causing material increases in arrears across the board.