New worry on interest-only loans | The Australian

By 19 October 2017May 31st, 2022Articles

Many interest-only borrowers are failing to save any money, even though their monthly mortgage repayments are about 40 per cent lower than home loans paying off principal and interest.

It’s a further concern added to a growing list of worries about the threat interest-only loans present to the financial system.

Interest-only loans, which don’t require any payment on the loan’s principal amount for a period of around five years, have come under intense scrutiny over the last year.

In March, the Australian Prudential Regulation Authority announced strict rules limiting the amount of interest-only loans to 30 per cent of a bank’s new lending. That came on top of a 10 per cent annual growth cap on investor lending. Interest-only loans account for more than 40 per cent of loans in the market.

Regulators are increasingly concerned borrowers with interest-only loans may not be able to pay down the loan at the end of the five-year period, may not be able to refinance their loan with another interest-only loan due to rising interest rates and lending requirements, and may be unaware they are not paying off the principal on the loan.

Fresh research from Morgan Stanley has found around 40 per cent of borrowers saved nothing in the past year. However, analyst Richard Wiles found interest-only borrowers were saving less than average despite having much smaller monthly loan repayments.

“This gap is most pronounced for owner-occupiers, where 52 per cent on interest-only loans are not saving vs. 36 per cent on principal and interest,” he said. While about a third of all borrowers are more than a year ahead on mortgage repayments, about one third have no buffer.

Mr Wiles said with falling incomes, rising cost of living and tighter access to credit, consumer spending in the economy will slow. “This should flow on to business profits and employment, leading to a rise in losses on business and consumer unsecured (loans),” he said.

A recent report from UBS analyst Jonathan Mott concluded that one-third of borrowers with a interest-only loans don’t realise they aren’t paying back any of the loan’s principal. The UBS report also found Australian banks were sitting on $500bn worth of “liar loans” sold to borrowers who gave lenders false information to get a mortgage.

Since APRA brought in the new rules affecting interest-only loans, banks have hiked rates for borrowers in an attempt to encourage them to switch to loans with principal repayments.

Rates for interest-only loans, in response to new prudential restrictions, have been lifted by 46 and 76 basis points for owner-occupiers and investors, respectively, on average. A quarter of interest-only borrowers now facing a “high” level of financial stress said they were considering selling their house, according to UBS.

Interest-only loans are considered more risky than other loan types as they are usually held by investors with more tenuous links to their properties than owner-occupiers, or by borrowers who cannot afford to pay off the principal.

In a stark admission of the heightened threat to financial stability amid endless increases in household debt and rampant property prices, the RBA on Friday said it will launch “top down stress tests” of the banking system, which will be carried out on top of the supervision from APRA.

Source: The Australian