Fears about roll over of interest-only loans

FOR years, a property boom in Australia has been partly fuelled by the growth of interest-only loans but this is coming to an end.

In the next three years, the Reserve Bank has estimated 200,000 home loans will roll over to principal-and-interest payments, bumping up mortgage repayments by about $7000 a year for the average borrower.

At the same time, changes to lending practices has made it more difficult for people to refinance their loans and delay increases to their repayments.

"The kind of nightmare scenario is where a lot of people need to sell all at once and that’s where you see a kind of fire-sale mentality … and it could lead to significant financial instability," UNSW economist Professor Richard Holden told 7.30.

Interest-only loans have become popular in Australia, partly because of the country’s unique negative gearing provisions. By 2015, interest-only loans made up almost 40 per cent of the country’s outstanding credit.

"This is unusual and the tax system in Australia drove it," property analyst Pete Wargent told news.com.au. "In the UK, it would be less than half of that and in other parts of the world it is not as popular."

Mr Wargent said a major driver of these loans was the ability to claim a tax deduction on the interest paid.

Typically, an interest-only loan would automatically reset to higher principal-and-interest payments after five years but Mr Wargent said it had become popular for investors to roll their loans over to interest-only loans "in perpetuity".

The federal government, Reserve Bank and Australian Prudential Regulation Authority became concerned about the growing popularity of these loans last year and decided to limit them. They can now only make up a maximum of 30 per cent of loans. They also encouraged lenders to make interest rates higher on these loans, and in some cases rates are about 1 per cent more expensive than on principal-and-interest loans.

Mr Wargent said the crackdown appears to have been effective in getting people to switch to principal-and-interest loans early and in reducing the popularity of interest-only loans.

"In a short time, we’ve seen a sharp decline in interest-only loans and this will continue in 2018," he said.

– realestate.com.au