Interest Only rates are on the rise

APRA (Australian Prudential Regulation Authority) has recently put it's foot down on interest only loans in a bid to slow down the property market and to 'derisk' the financial system. The regulator has advised that moving forward interest-only loans must be restricted to 30% of new residential mortgage loans. The percentage of interest only loan has not been below 30% since 2008. 

Interest only (I/O) lending is currently sitting at 40% of new lending, a level that APRA have said is extremely high by international and historical standards. 

There are obvious reasons why borrowers are more inclined to go with interest only loans. The first and perhaps most prominent reason is because of negative gearing. 

(Negative gearing means that the interest you are paying on the loan is more than the income. As a result you are making a loss.)

One of the other very obvious reasons for the push for interest only loans is that the house prices in Australia are unaffordable if the repayments were structured as Principle and Interest, while as Interest Only they can scrape through and maintain that quintessential Australian dream of property ownership.

Some of the ways that the banks are going to attempt to curb Interest Only lending are:

  • Increasing I/O rates. Many lenders have already increased their rates for both Owner Occupied and Investment loans. Typically the Owner Occupied increases are ranging from 0.10% - 0.20% and Investment increases by 0.20% - 0.35%. It is only a matter of time before all lenders increase their rates. Not surprisingly, some lenders have also announced that they are going to be reducing their Owner Occupied Principle and Interest rates.
  • Ensuring that I/O lending does not exceed an LVR (loan to value ratio) of 80%. 
  • Review serviceability metrics, including interest rate and income buffers are set at higher buffers for the current climate to restrict I/O lending
  • Withdrawing the option for I/O loans and only allowing Principle and Interest Loans
“APRA’s limit on new interest only lending is 30 per cent of new residential mortgage lending, so we have to continue to make changes to our interest only rates and lending policies to meet this benchmark,” Westpac consumer banking boss George Frazis said.
“Today’s decision is not in response to the Federal Government’s recently announced bank levy,” Mr Frazis added.

On a $800,000 loan the typical monthly principle and interest repayment is $4,796 however the interest only repayment is around $4,000, quite a considerable difference especially for families that may be struggling and already stretched financially.  

Even as recently as this afternoon there have been considerable information in the media about CBA and NAB needing to increase their Interest Only rates again, or else they will be inundated with a flood of high risk borrowers.