Interest-only borrowers have usually paid a higher interest rate than their principal and interest counterparts, but the gap, at present about 0.5 per cent, is now significant.
by Richard Wakelin – Source AFR 5/2/18
Interest-only loans have been a mainstay of credit for property investors for the past 20 years, representing about 65 per cent of all investor loans in recent times.
With 10 months having elapsed since the prudential regulator instructed banks to tighten their practices around the use of interest-only loans, it’s worth evaluating the impact this has had on the market.
There have been a number of ways these rules have been felt by investors, according to the soundings I’ve taken from mortgage brokers and investors.
First off, banks have become more thorough about validating mortgage applications to ensure income and expenditure claims are accurate. This means it’s now much harder to obtain interest-only loans at higher loan-to-value ratios. Whereas in yesteryear obtaining an interest-only loan with a 90 per cent LVR ratio was common, banks are now less willing to provide interest-only loans for those seeking loans above an 80 per cent LVR.
The shift from interest-only to principal and interest mortgage repayments has resulted in a significant jump in mortgage payments. Col Bennetts.
Interest-only borrowers have usually paid a higher interest rate than their principal and interest counterparts, but the gap, at present about 0.5 per cent, is now significant. The position looks even more stark when compared with a typical principal and interest paying home owner borrower, who is often paying 100 basis points less for their mortgage.
All loans eventually have to be repaid, so interest-only loans always convert to standard repayment loans after an agreed period – unless a new interest-only loan is established. A 10-year repayment holiday was common in the past, but new investors can generally only expect a 5-year holiday period and rolling over a loan with an expiring holiday into a new one is more difficult. This is especially the case if a borrower is older and the extension of the loan’s term takes it well into their retirement years.
The shift from interest-only to principal and interest mortgage repayments has resulted in a significant jump – often 50 per cent – in mortgage payments. But it is an entirely expected occurrence for prudent investors. Moreover, most investors will have seen a material improvement in their income – both from the workplace and from rental income – over the five to ten years since they took out the initial loan, so are able to absorb the increase.
But there have been claims that a number of property investors – including 20,000 Brisbane-based investment club members – have effectively lost the option to roll over their interest only loans and are struggling with the additional burden. Moreover, it is suggested that this could become a systemic issue that undermines the property market.
I am sceptical that this is a widespread problem that has a contagion risk for the market. Brokers tell me that most borrowers can roll over their interest-only loan, either through their current or an alternative lender, unless their circumstances have deteriorated markedly. Rather, the situation is a slightly earlier denouement of a horror story for some marginal borrowers in marginal locations; individuals who were allowed to over-extend themselves and buy poor-quality property in economically challenged regions that have seen little rental growth in the last few years. The Australian Prudential Regulation Authority’s tweak of prudential rules didn’t fundamentally diminish their circumstances. It has just brought their weaknesses to light a little sooner.
Ultimately, the new rules will be good for the property market by reducing the likelihood of the ill-equipped entering the market or obtaining finance for second-rate investment propositions. That is to be welcomed.