Why do the regulators want to reduce interest-only lending?
For all new loan applications made in Australia at the moment just over 40 per cent of these are for interest only mortgages – both home and investment. However, by world standards this is very high for interest-only lending with an average across the world of around 30 per cent of all loans introduced seeking an interest only term.
The disparity is why the regulators are concerned and why the sudden focus to now enforce limits to interest-only lending to reduce that percentage back down to the historical worldwide average.
Whether this is right or wrong, only time will tell. One concern that I have is that when you just take averages across the world like this, it does not take into account whether populations or economies are growing like ours is and continues to do so in Australia.
Where can we see the changes in finance lending?
The next, and potentially the bigger issue is how are banks going to take actions to reduce these inflows to a regulatory enforced 30% level?
It’s an interesting question and in recent weeks we have spoken to many of our lenders to discuss what may or may not be happening. We have spoken to some lenders that have had in recent times, new applications for interest only lending in excess of 50% of all new applications and we are seeing immediate restrictions coming in place for these.
So, what is changing? Well here are some of the things that are currently happening:
- Some lenders are restricting interest-only on any loans above 80 per cent i.e. mortgage insured loans are no longer acceptable.
- Some, with high exposure to interest only loans, are even restricting the LVR’s back to 70% to reduce their inflows.
- One major lender has refused to accept any investment loans refinances until they get their 10% investor cap back in order
- We have wide interest rate disparities now between Principal & interest home loans and interest only home loans
- These disparities are even wider and the rates higher now for interest only investment loans
- A lot of expat lending is now restricted solely to principal & interest
These lending restrictions are a changing of the guard of sorts.
The thing is the higher interest rates for investor loans were supposed to curtail demand, but it didn’t happen.
That’s because some markets were performing at 12 to 15 per cent price growth per year, so an extra 0.5 or 0.75 in interest rate didn’t make much difference to investors at all.
It makes no sense to just ramp up interest rates in the current market conditions – apart from the fact it makes banks more money.
Some lenders have also come out and said “no” to interest-only home loans completely and anyone borrowing for a PPOR will need to pay principal and interest.
What changes are forecast for the future?
Don’t be surprised if we see further changes such as:
- All home loans will need to be on a principal & interest basis
- Some applications for properties in certain areas (postcode restrictions) will have to pay Principal & Interest whether they like it or not.
- Some lenders will even, in the short term, refuse any interest only lending at all to get their caps back in order.
- Far greater scrutiny on interest only loans expiring from their original term and seeking a further interest only term.
That’s because those borrowers haven’t really put any capital down on the loan and they’re really just banking on the property increasing in price, which may or may not happen. With less contribution, to rebalance this, paying Principal & Interest isn’t a bad option. At the end of the day, in the longer term irrespective of any short term tax disadvantages, it will assist the client with their long term wealth creation.
But there has to be a financial commitment from the borrower in such a highly-leveraged transaction in my opinion.
Restricting LVRs on properties in oversupplied areas is probably a smart idea, too.
What’s the outcome from all these changes?
So what’s the likely outcome of all of these levers being pulled?
It’s clear the regulator wants to restrict the housing market but it’s really only Sydney where there is potential for major problems but this isn’t really an Australian-wide issue.
The issue is they are using only one blunt instrument when it should be postcode or location restrictions in recognition of geographic market differences.
I believe that the regulators can be a bit smarter or a little bit more targeted with the enforcement of these regulatory restrictions. And even better still, wouldn’t it be refreshing if the changes and the proposed “end game” was actually communicated to everyone with what they want to achieve?
If they’ve completed the right level of research, they could restrict LVRs in specific postcodes with potential issues and leave the parts of the country where markets are sustainable well alone.
Otherwise, there could be unintended consequences.
How does the balance of the market hold the regulators accountable for their actions? That’s what really annoys me. It’s not a transparent process.
They’ve just said “this is going to happen”, but it’s vitally important that we get the balance right – and that doesn’t seem to be happening if you ask me.
Very interesting times lay ahead and as consumers, don’t be surprised if you asked questions you’ve never been asked before or have actions implied upon you that you may not have sought.
In a market contraction, which is what this is, you have to be flexible in your thinking to achieve your own “end game”.
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The information provided in this article is general in nature and does not constitute personal financial advice. The information has been prepared without taking into account your personal objectives, financial situation or needs. Before acting on any information you should consider the appropriateness of the information with regard to your objectives, financial situation and needs.
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