Demise of interest only loans Raj Ladher
Interest only loans are where you merely pay back the interest of a loan to the lender – so if you borrowed $500,000 and made repayments for five years, your balance would still be $500,000. They are designed predominantly for investors for cash flow and tax deductibility purposes.
In March 2017, the Australian Prudential Regulation Authority (APRA) put a restriction of 30% of all new residential interest only loans accepted by the banks. The cap was placed to prevent borrowers over-leveraging themselves along with being prudent in a volatile property market Australia-wide.
In order to control the demand for interest only lending, banks applied two levers - interest rates and Loan to Value Ratios (LVR).
Interest only lending is now anywhere from 0.25% to 1.00% higher in interest than Principal and Interest rates. This can be quite significant on larger loans, i.e. 0.50% on a $500,000 30 year term loan is approx. $150 per month more expensive.
Banks also now have maximum LVRs in place for interest only lending, i.e. most lenders will only give interest only loans below LVRs of 80%. Interest only loans for owner occupiers are scarce and borrowers would need a good reason for approval such as going on maternity leave or home renovations. However even in these circumstances, interest only loans will only be given for a short term of say one to two years.