Interest only loans - Do as you are told!

Interest only loans – Do as you are told!

Your interest only loans are in the firing line

The Australian Prudential Regulation Authority (“APRA”), the regulator of banks, super funds (and others), announced new rules yesterday, which will stymie banks ability to provide interest only loans to its customers, and allow them to charge more (in the form of higher interest rates) for the ones they do approve.

So what has changed with interest only loans

Yesterday APRA announced that banks must limit the volume of new interest-only lending to 30% of total new residential mortgage lending!Simply put this means the banks have less money available to lend to both investors AND owner occupiers who want an interest only loan!It also means that as the supply of funds available for such lending, the banks will make it tougher for an investor to be approved (arguably they can be more choosey given they have more people wanting such loans than they are able to approve) AND they can charge higher interest rates on the ones they do approve.

Further instructions form APRA regarding interest only loans

In their letter to the banks, APRA also advised –

  • Banks are to –
    • “place strict internal limits on the volume of interest-only lending at loan-to-value ratios (LVRs) above 80 per cent; and
    • ensure there is strong scrutiny and justification of any instances of interest-only lending at an LVR above 90 per cent
  • Further they are to –
    • manage lending to investors in such a manner so as to comfortably remain below the previously advised benchmark of 10 per cent growth;
    • review and ensure that serviceability metrics, including interest rate and net income buffers, are set at appropriate levels for current conditions; and
    • continue to restrain lending growth in higher risk segments of the portfolio (e.g. high loan-to-income loans, high LVR loans, and loans for very long terms).

Why are they doing this to interest only loans

Well, quoting APRA Chairman Wayne Byres in the Press Release -“APRA expects ADIs (Ed: banks) to target a level of investor lending growth that allows them to comfortably manage normal monthly volatility in lending flows without exceeding, the APRA, benchmark level.”

However, additional supervisory measures, particularly in relation to the high level of interest-only lending, are warranted. Mr Byres said: “Our objective with these new measures is to ensure lenders are recognising the heightened risk in the lending environment, and that their lending standards and practices appropriately respond to these conditions.

Mr Byres said lending on interest-only terms represents nearly 40 per cent of the stock of residential mortgage lending by ADIs – a share that is quite high by international and historical standards.”Clearly the regulator feels the banks are providing too much easy money (money they aren’t asking customers to pay back, just pay the interest on) to use for purchasing residential property.  This in turn is contributing to the sky rocketing property prices on the East Coast, particularly obviously Sydney and Melbourne.That of course is small comfort for WA property investors, who have seen flat if not negative price movements for several years, nothing even in the ball park of the increases seen over East.

Impacts for our Clients and those looking to accumulate wealth through property

In short, it looks like you will be paying more for an interest only loan than you were.  It is also going to become more difficult to get a new interest only loan (and likely to be able to renew existing interest only loans when the term expires).In particular, if your serviceability is not quite as strong as one might like, your application will be more closely scrutinised and the chances of a knock back have increased. This is particularly important to keep in mind if you have a loan due to expire soon (remember, many interest only loans, particularly investment loans, have shorter terms than a traditional P&I (principal and interest) home loan.The expected increased interest costs come on the back of a number of recent rate increases from the banks.  For those invested in WA, it also likely comes right after a drop in rental income (the vast majority of residential, and for that matter commercial, landlords have had to cut the rent they charge their tenants over the past 6 to 12 months).

What to do about it

Some could try engaging with your bank, particularly if you have a Private Banker, in order to try to sweeten your deal and ensure increases are at a minimum  But in reality for most of us this won’t be possible.That being the case the key is to review your budgets (and build one if you don’t already have one), ensure you fully understand what your commitments will be over the coming weeks, year and ideally 3 years, and then ensure your personal, discretionary spending doesn’t go outside what you can afford.See the APRA Media Release for more details.