Perils of interest-only loans

Should property investors heed the warnings and steer clear of this type of lending, asks Sophie Elsworth

A LARGE number of property investors and owner occupiers believe interest-only loans are good despite regulators forcing financial institutions to tighten this type of lending.

For decades interest-only lending has been a popular option. Investor debt is kept at a higher level, meaning a higher amount of interest is paid, but it’s a tax-deductible expense.

For owner occupiers, interest-only is not usually a recommended option because the interest paid is not tax deductible. If an owner occupier chooses this option, it ultimately means they will never own their own home.

A new study by Gateway Bank, which quizzed 1000 borrowers, found 62 per cent of investors and 43 per cent of owner occupiers thought interest-only loans were good.

In 2016 the banking regulator, the Australian Prudential and Regulation Authority, put the brakes on interest-only lending.

Latest figures show the interest-only value of new loan approvals plummeted from about 40 per cent in the March 2017 quarter to 15 per cent in the June quarter this year.

However, Gateway Bank chief executive officer Paul Thomas said interest-only loans were not all bad and could be used sensibly.

“Interest-only loans are a bit like a credit card … if you use it wisely it is a good thing, but if you don’t use it wisely it’s a bad thing,” he said.

“If you are an owner occupier, in certain times, you can use it but I always counsel caution.

“If you are an investor looking for the ability to maximise your tax deductions for your interest-payments, Owner occupier, principal and interest Owner occupier, interest-only Investor, principal and interest Investor, interest-only I think then that interest-only is a good option.”

Mr Thomas warned that a big issue with interest-only loans was “repayment shock,” when a customer’s interest-only period expired and the lender forced them to start paying principal and interest.

Often their repayments rise significantly. 4.32% 4.83% 4.76% 5.07% MONDAY, NOVEMBER 26, 2018 Repayments $1488 $1208 $1567 $1268

Financial comparison website RateCity’s spokeswoman, Sally Tindall, warned that making interestonly repayments came at a cost.

“Owner occupiers are typically paying 0.51 percentage points more by opting for interest-only repayments,” Ms Tindall said.

“Investors paying interest- only are, on average, paying a rate that’s 0.31 percentage points higher.”

If an owner occupier customer did this for the first five years on a $300,000 30year home loan they would end up paying more than $27,800 extra in interest charges.

Ms Tindall warned while making interest-only repayments in many cases enabled lower monthly repayments it could provide borrowers with “a false sense of what’s affordable.”

“Interest-only terms delay the heavy lifting that comes with paying down your debt but, for owner occupiers in particular, they often just exacerbate the problem in the long term,” she said.