Many borrowers have taken out interest only loans without fully considering the risks and limitations associated. The Reserve Bank of Australia (RBA) have made the decision to hold the current cash rate at 1.50 per cent.
However, some major banks in recent months have increased their retail interest rates. This is already putting some borrowers under financial stress. With interest rate rises more likely than reductions, the potential for forced property sales is increasing.
The Australian Prudential Regulation Authority’s (APRA) recent clamp down on interest only mortgages appears to have had the desired economic effect. There move has lowered the level of property lending to investors. Figures released at the end of August show that the aggregate value of interest only loans fell by $2.3 billion in the June quarter. APRA has told the banking sector that they can only lend up to 30 per cent of their new mortgages on interest only terms. Many of the banks have lifted their interest rates in this space to curb the demand for interest only terms.
So what the difference?
Interest only loans require the borrower to only pay the outstanding interest on the amount borrowed.
Principal and interest loans require the borrower to repay the interest component plus a portion of the principal loan balance. Thus, reducing the outstanding loan amount with each repayment.
Why utilise an interest only loan?
Many seasoned property investors utilise this loan repayment method because the interest repayments are deductible. The view would be to generate sufficient profit over time to offset the cost of interest on their loans after taxes. This however works on the notion that property prices will continue to increase with time.
What are the consequences?
There are a number of consequences for investors not understanding the differences between these loans. Rates are expected to rise in the future as interest rates in offshore financial markets rise. The bulk of Australian banks source their wholesale cash from overseas markets. So should those markets rise then ours will follow suit shortly after. Ultimately, borrowers on interest only terms need to be alert to the likelihood of this occurring.
UBS analyst Jonathon Mott who has drawn attention to this concern stated, “whilst these loans are well secured, we believe many borrowers may face substantial stress as interest rates rise or when they revert to principal and interest”.
Have you considered this… Are your loans are being structured in the most effective way? What effect a change to a principal and interest loan term will have for you?
Should you wish to discuss your current lending position please contact us on (07) 3284 7875 to arrange an appointment. We can provide a range of services to answer all your question in many areas of your financial well being.
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