Interest-only mortgage downsides

Are you better off just paying the interest on your mortgage?

Interest-only mortgage lending has come in for scrutiny over the past year, amid regulatory concern on both sides of the Tasman that the lending practice could create financial instability.

‘‘Interest-only’’ works well for investors claiming tax benefits, and those happy to bank on price rises to give them equity gains.

It is a lot less common than it once was, due in part to low interest rates and banks’ stricter lending criteria.

Data from the Reserve Bank shows that there was $1.65 billion of new mortgage lending issued on an interest-only basis in November, including revolving credit facilities.

That was up from $1.44b in October 2017, but still well down on the $2.53b issued in November 2015. In 2016, when the property market was hot, 40 per cent of new mortgages by value were interestonly.

In Australia, banks have been told to limit new interest-only lending to 30 per cent of new mortgage lending. The big banks there had been lending as much as 49 per cent of loans on interestonly terms. New Zealand’s level in November was just under 19 per cent.

Interest-only borrowers are more exposed to interest rate rises because the amount of principal owed does not drop, leaving less room to move if required.

Many plan to sell as their strategy to eventually rid themselves of the debt – but if the market turned, that could be difficult.

It’s a popular option for investors, who are only able to claim the interest portion of their mortgage payments against their taxable income. Reserve Bank data shows they have $28.7b of interestonly mortgages, or 41 per cent of all investor mortgages, compared to just under $26b, or 15 per cent of all lending, for owner-occupiers. That does not include revolving credit facilities.

David Windler, a mortgage adviser with The Mortgage Supply Co, said banks had tightened their criteria and it was now harder for people to take out an interest-only loan on an owner-occupied property. ‘‘Not so much for investors. It’s still pretty accepted that property investors are likely to want their lending on interestonly and that’s still, as I see it, not a problem.’’

He said it was not always true that interest-only lending was more risky. ‘‘With any lending that anyone undertakes the only risk is your ability to pay. If you believe that standpoint interestonly means less risk because it gives you more ability to pay.

‘‘But at some point in people’s lives their income runs out and they retire. By [that time], they want to have no debt.’’

Banks were now less likely to accept a strategy that relied on the eventual sale of a property.

Andrew Bruce, president of the Auckland Property Investors Association, said he had interestonly loans when he started out in property investment.

‘‘It’s an ongoing debate in the property industry what’s the better way to go. Purely from a tax deductibility point of view, you should pay interest-only on your investment properties. But there’s also the sleep-at-night test.’’

Banking expert Claire Matthews, from Massey University, said how risky it was would depend on the reason for it.

‘‘It is sometimes used to reduce the cost – but that shouldn’t be the case now, with interest rates continuing to be low and providing an opportunity for borrowers to pay off more of the principal pending the interest rate rise, which will come eventually.’’

Sorted spokesman Tom Hartmann said it was the equivalent of running in place financially.

‘‘For homeowners just looking to reduce their out-of-pocket expenses in the short term and hoping that their house’s value will go up in the long term – it’s challenging to tell the future, and pulling that off can be a bit tricky. A change in the housing market could render a very different picture.’’