Lending update – do you have an interest only loan?

Do you have an interest only home loan with one of the major banks? Have you seen what your new interest rate is or will soon be changing to? If you do have an interest only loan, I’m sure you would be aware of all the recent press regarding the latest round of regulatory enforced changes to these specific home loans.

If you aren’t aware of the background to these latest changes, let us explain a little further. The regulators over recent years have become more and more apprehensive about the composition of the major banks’ loan books in light of the current value of the Australian property market. They have been targeting key areas within these loan books as they try and reduce the possible risks the banks could face if there was a dramatic and wide spread decrease in property prices. The first move by the regulators about 18 months ago was to slow down the growth in investment property lending and now they are focusing on interest only loans.

What is the Impact?

The impact of this new directive has been dramatic. All the major banks and most of the second tier banks have continued to increase the difference in rates between principal and interest repayment loans and interest only loans. Two major banks have even stopped accepting owner occupied refinance applications altogether if you want interest only repayments. The change in rates has been substantial, this is now the second major increase which together with those made in March, now takes the average difference between variable rates on an owner occupied loan with principal and interest repayments versus those with interest only repayments to approximately 0.56%. On a $500,000 loan that is an extra $2,800 a year in interest and on a $1million loan approximately $5,600 a year.

Similar changes have occurred on investment loans, with that increase being 0.48%. The bigger impact for investment loans being exaggerated by the previous regulatory changes eluded to above. This has now resulted in the average investment purpose, interest only, loan being 1.05% more expensive than an owner occupied, principal and interest only. Whilst fundamentally one can understand why these rates should be different because of the different risk between an owner occupied loan and an investment purpose loan, this increase in cost has happened within the last 12 months.

It is easy to be cynical when listening to the banks complain about the cost of the bank levy. Whether you agree with the levy or not, they are recouping the cost very quickly. Based on these recent rate increases and using the publicly available information regarding the bank’s home loan books, it would appear that the impact of these two rate increases will cover not just one year of the levy but the full five year cost of the bank levy within the next 12 months. The question begs, have these rate increases all been taken too far and to who’s benefit? Should the banks possibly only be changing rates for new loans, not repricing their entire loan books?

So what does this all mean and what can you do about it.

I would like to start by saying that everyone’s situation and position is different, and the options below should be considered in that context, however some of the choices to consider are as follows:

1. Staying with the same lender but converting the monthly repayments from interest only to principal and interest. Does it strategically make sense to do this and can you afford the extra monthly cash flow requirements? Based on approximate current market rates, changing from an interest only repayment to a principal and interest repayment, on a loan amount of $500,000 would be an increase of approximately $382 per month and on a $1million loan an increase of $765 per month.
2. Potentially refinancing to another provider. Based on the variable rates and the discounts currently being provided by the banks there is a large difference now between the major bank and second tier banks on interest only loans. On average the difference in rates is approximately 0.85% on an owner occupied interest only loan and 0.80% on an investment, interest only loan. Quite a substantial difference, if rate is a major influencing factor in deciding where you want to place your loan.

The landscape for residential loans has changed dramatically over the last 12 months and this looks set to continue, as a client, we urge you to be aware of your own loan position and question whether you are in the most suitable loan product for your specific circumstances. The LogiX team is always here to assist with a complementary debt review or an update on current market changes, please contact Gareth, Murray and Paul if you have any questions.