You may be aware that in December last year, the Australian Prudential Regulation Authority (APRA) issued a statement informing lenders it was removing its 30% benchmark on growth in interest-only (IO) loans. This saw the beginning of 2019 mark the end of the ban placed on interest-only mortgages by APRA in Australia.

As such, we thought that we would shed some light around the lifting of this ban and what this means for home buyers and investors who are potentially looking to secure this type of funding.

We will also delve into some of the pros and con’s about this type of lending that have been widely documented by financial services professionals in the media.

Please note however that the information you read here is purely to provide you with insight into interest-only lending and not to provide advice. For detailed information and advice, please contact a certified financial adviser or accountant.

Originally, APRA introduced the ban on interest-only lending over growing concerns about the rise in “higher risk lending” and the increasing levels of debt among Australian families. The aim was also to:

–    Cap investor lending

–    Reduce high-risk lending

–    Improve bank lending standards

–    Reinforce sound lending practices

As of December 2018, APRA concluded that the ban had ‘served its purpose’ to dampen risky lending, with APRA Chairman Wayne Byres stating, “the proportion of new interest-only lending has halved, and interest-only lending at high loan-to-valuation ratios has also declined markedly”.

So what exactly is an interest only loan and what are some of the potential risks and benefits in having one?

To summarise briefly, an interest-only loan allows you to minimise your mortgage repayments in the short-term while your property asset hopefully grows value in the long term. These loans are often popular with property investors as they are seen to ‘ease’ financial pressure in the early stages of buying a home.

According to Money Smart (operated by ASIC), home occupiers take out 25% of IO loans; however, investors make up the majority of those in possession of IO loans.

For those of you who are now considering an interest-only loan, it’s important to weigh up all the facts and be aware of all the pros and cons including the below.

Pros:

• The first few years of loan repayments are considerably more affordable, this is beneficial for first home buyers.
• Repayments are usually less due to the fact that you do not pay anything towards the principal amount. As a result, loan holders are left with an increase in cash flow for other purposes.
• They have the potential to free up cash flow for additional investments.
• They are useful for buyers who are looking to sell the property within a few years of purchasing it.

Cons:

• The principal amount of the loan WILL NOT reduce during the interest-only period.
• Interest-only loans have a maximum loan period of 5 years. At the completion of this period, the loan will revert to a principal and interest loan. This typically means that you will have HIGHER repayments when this period ends.
• While they may be cheaper in the beginning, IO loans are likely to be more expensive in the long run because the principal of the loan is not being reduced in this period.
• Should the property depreciate during the interest-only period, you will be left with less equity and refinancing difficulties.

If you currently hold an interest-only loan that is set to expire, due to the ban lift, you may be eligible for consideration of the below options:

• Negotiate an interest-only extension from your lender
• Devise a plan to begin repayment on your principal loan with your current lender
• Refinance your loan to an alternate lender. It is now possible to refinance to another interest-only loan with a different lender due to the lifting of the restrictions.
• Consider refinancing to a Principal & Interest loan with an alternative lender.

We hope that this article has shed some light for you on APRA’s lifting of the ban on interest-only lending.

As always, we recommend you seek proper advice from a trusted financial advisor before making any decisions.