APRA tightens up on Interest Only Lending.
Who is APRA? They are the ‘Australian Prudential Regulation Authority’. Their primary role is to oversee lending institutions such as banks, credit unions etc. as well as insurance companies and most members of the superannuation industry. They are a prudent regulator who values themselves as a ‘protector’ of the financial-well being of the Australian community.
Since March 2017, APRA has put a limit on interest-only lending to 30 per cent of total new residential mortgage lending, put restrictions on interest-only lending on loan to value ratios (LVRs) above 80 per cent, and asked for strong scrutiny of interest-only loans at an LVR above 90 per cent.
What is interest only?
An interest only loan is a loan that the property owner pays only the interest, not any of the principal on. Generally this is a strategy used by investors rather than home owners as the interest is a tax-deduction whereas the principle isn’t. It also helps investors free up cash flow so they can hold more property.
Tip – If your loan is variable you have the ability to make unlimited additional repayments if and when you choose – something that is not often mentioned and gives the wrong impression no principal can be paid.
So what is the risk of interest only lending?
APRA chairman Wayne Byres said the higher proportion of interest-only lending was indicative of a “higher-risk profile”.
The concern is that more home owners are applying for interest only lending due to affordability issues and so when the loan reverts to principal and interest they’ll really be in the poo. They’re also concerned that house prices will fall in value and the home owner could end up in negative equity.
They are concerns that interest only lending will encourage people to borrow more than they otherwise would. And that they are relying on capital appreciation rather than paying back the loan to make a ‘profit’.
* Source: Domain
What about giving consumers choice?
For some home buyers cash can be tight especially in the early years and while interest only lending isn’t ideal on your own home, it may be more favourable to give more repayment flexibility during the early years.
Others choose this method of repayment simply because they intend for the home to become an investment in the not so distant future. People are now moving house more frequently than they did in the past, which is a product of our fast-paced economy and global opportunities.
Home buyers should consider the risks and equally the merits of an interest only loan, given their individual circumstances and short to medium-term goals.
Our job is to have a conversation with our clients as part of the education process we provide, to ensure you are comfortable with your decision and understand the pro’s and con’s.
Sadly, it seems this decision is in the most part is now being made by APRA by forcing the hand of the banks to reduce the “perceived risk” and protect people from themselves. A bit of an overkill as one size certainly does not fit all.
If you have any concerns about this topic or have any questions, as always please get in touch with us.