Investors coming back to a matter of principal

A GROWING number of borrowers are turning their backs on the once-popular interest-only (IO) loans and instead focusing on shaving down their debts by paying down the principal.

The recent crackdown on IO loans by banking regulator, the Australian Prudential and Regulation Authority (APRA), has resulted in banks tightening the screws on these deals.

Hikes to IO rates combined with strict limitations on this type of lending to 30 per cent of all new home loan business by lenders is resulting in borrowers being encouraged to pay down their debts.

Figures released by the Australian Securities and Investments Commission (ASIC) this month show the nation’s major banks have cut back their interest-only lending by $4.5 billion over the past year, proving the crackdowns are working.

ING Australia’s head of retail banking Melanie Evans said one third of their customers have IO loans but most of them are investors.

She warns while IO can suit some borrowers, in most instances mortgage customers should be focused on paying down their debt.

“The majority of these borrowers are investors that are suited to interest-only loans because they have a capital gain in mind and intend to buy and then sell before the interest- only period is over,’’ Ms Evans said. “Interest-only loans can work for owner occupiers with unusual cash flow too, for example an interest-only loan might be useful for those starting a family and momentarily living on one income or a business owner with lumpy revenue.” Data from financial comparison website Finder.com.au shows IO customers do pay more – paying on average 4.87 per cent on variable owner occupier loans compared with 4.3 per cent for principal and interest (P & I) loans.

IO investors pay an average of 5.28 per cent, compared with 4.84 per cent for P & I.

Lender ME’s head of home loans Patrick Nolan said of their existing investor book, about 56 per cent are on IO deals, while just 11 per cent of owner occupiers make IO repayments.

“Particularly for owner occupiers, by paying interestonly you are not paying down the principal of the property and if that’s your home, clearly you want to get into a position where you own it outright,’’ he said.

“Some owner occupiers use interest-only for those one-off situations, maybe a pregnancy or an unexpected illness or a very dramatic change in circumstances where they need to manage their cash flow.

“With the movements in rates with IO portfolios we are seeing customers move to principal and interest.”