Principal reasons for interest only limits

TIM McINTYRE

BACK in 2013, I spoke to a man who had just managed to buy a home in Sydney’s inner west with his wife and young family.

They had gone $150,000 over their original budget, after property hunting without success for eight months and becoming fed up. They were able to go so far over budget by taking out an interest only loan.

The man reasoned that an interest only period of five years would be enough time to get a promotion or pay rise at work and be in better financial shape when the time came to pay down the principal.

Since then, interest rates have fallen further and remain at historic lows, while property values in Petersham, where they bought, have increased by another 70 per cent, according to figures. They got lucky.

If values had stalled and interest rates risen, they would have been in hot water.

Interest only loans are traditionally favoured by investors looking for a cashflow positive portfolio; but the Australian Prudential Regulation Authority (APRA) is clamping down, limiting interest only lending from banks to 30 per cent of all loans.

Banks have curbed demand by making interest only borrowers pay higher interest rates. This will drive some investors away, while owner occupiers should be avoiding those loans altogether.

Ever-tightening rules around responsible lending mean some banks are pulling out of interest only products completely, or reducing terms from 10 years to five. Others are making doubly sure loan applicants can service their mortgages.

“You have to prove you can service principal and interest repayments before being accepted,” Mortgage Choice’s Jessica Darnbrough says.

“Mostly we’re seeing (banks) raise interest rates on interest only products, so they are encouraging owner occupiers into the principal and interest space.”