The media has recently been focusing on the severe scrutiny of the investor only loan products, as highlighted by the Banking Royal Commission. Some media grabs have gone to the length of calling the interest only situation as a ‘ticking time bomb’. So what are the facts behind the scrutiny and how might this become an issue for the wider Australian community.

Size matters – Interest only loans ($549 billion)

Currently interest only (I/O) loans are proportioned at around $549 billion, or around 35% of all outstanding home loans. Surprisingly this is split fairly evenly between investors and home owners. The number of these loans totals 1.56 million, with loans usually come up for review every 3 to 5 years.

What does has a number of economic analysts concerned currently is the changes to how these loans will be scrutinised by the banks going forward. Lenders are now required to make a new assessment of the borrower when loans when they come up for review. These I/O loans are typically popular with investors as they provide the ability to hold an asset without the ‘burden’ of higher repayments (The loan principal). This means more money to the investors pockets from rental income, and lower or perhaps more affordable interest payments for the property owner. Effectively lowering the hurdle when it comes to the ability to purchase the property in the first place.

Tighter lending standards are coming

The tighter lending standards include rental income assessment cut to 80% to allow for vacant periods, borrowers must have a stated robust plan to repay the capital off the loan, not including the profits from sale of property as this is not always guaranteed. Loans are now also to be assessed to assume they are a principal and interest, thus removing the lower hurdle for potential new purchasers and potentially impacting those borrowers on the cusp of affordability. This thorough must all be documented by the bank in case of future actions of the borrower.

If a loan comes up for review and fails to be renewed borrowers will have limited choices. They can shop around for a alternative lender or move to a principal and interest loan which would effectively double the monthly repayments. Considering that half of all investment loans are negative cashflow already on a net rental basis, this begs the question where would the additional 50% repayments come from? Borrowers could be pinched into a forced sale if this is deemed unsuitable or unattainable by the investor, out office has seen multiple of these investors do just that already and we believe this may be a trend that snowballs over the coming years.

Remember the US ‘Sub Prime’ mortages

Multiplied across the nation and this could lead to a headwind for property prices as the supply will have a impact on prices along with a potential broader tighter credit environment. Its interesting to note that in the US such I/O loans are described as Sub Prime and are often discouraged, we have all heard of the term sub prime which was the apparent systemic cause of the US credit crisis. With 35% of all Australian mortgages in the ‘sub prime’ bucket its hard to imagine what might be the repercussions of disorder in this borrowing sector.

If you would like to know more about the specific impact of your interest only loan, contact us for an assessment.