A non-major bank has signalled it may be time for investors to consider interest-only loans amid rising mortgage payments.
However, two mortgage brokers cautioned others about advising clients to enter interest-only loans, emphasising the need to fully explain and consider both the risks and rewards.
Offering a host of investor-friendly product options, Auswide Bank has committed to accommodate brokers looking to assist investor clients currently struggling with cash flow.
Tracy Field (pictured above centre), head of third party at Auswide Bank, encouraged brokers to offset rising interest rates and identify investment lending opportunities that meet the bank's campaign criteria, offering potential interest rate discounts.
“Clients who bring owner occupied lending and investment lending to Auswide Bank at the same time are eligible to receive a bonus discount off their investment interest rate of up to .20%,” Field said.
“Provide some certainty in the mortgage cost of the investment loan for your clients. Consider giving your clients the ability to limit any shortfall in their cashflow with a fixed rate product, particularly where there is no rate differentiation between principal and interest (P&I) and IO repayments.”
However, while interest rate discounts were “a big factor”, they were not the sole factor, said Sam Giardina (pictured above left), director of Sydney-based brokerage Aventus Finance.
“We look at the features and flexibility of the product, and if it will accommodate to what they are looking to achieve,” Giardina said.
Giardina said it was “ultimately dependant” on the client and what they wanted to achieve.
“By figuring out their goals, we can build a strategy around that,” he said. “If the client is feeling the pinch of rising interest rates and wants to offset some of those rises, then interest-only repayments may be a suitable solution to get them through this period.”
Redom Syed (pictured above right), director of Confidence Finance, said in some cases where cash flow was very stretched, switching to interest-only was an “effective short-term solution”.
“It does cost more over time though, so it’s a balancing act about current cash flow versus higher interest costs,” Syed said.
The timeline of interest-only loans
Worried that interest-only lending could create a situation where high-risk homebuyers become overexposed, APRA had closely monitored the regulations surrounding interest-only lending since 2014.
By 2017, interest-only lending made up 64% of investment lending with a further 23% evident in owner-occupied lending.
This caused the prudential regulators to announce new measures for banks to cap their new interest-only lending to 30% of their total new residential mortgage lending.
While investors and owner-occupied borrowers made extensive use of interest-only borrowing for a range of reasons, it was the residential housing investors that made the most use of these loans.
“With interest payments on investment loans being tax deductible it reduced the incentive to pay down the principal on investment lending,” said Field.
“Investors also preferred interest-only loans to principal and interest loans in the past because they offered greater repayments flexibility.”
Another reason, said Field, was that interest-only payments provided investors with the ability to better manage their cash flow.
“Borrowers found they could level out fluctuating incomes or build buffers for future expenditures on their investment properties, such as renovation or larger maintenance items,” Field said.
The reasoning was that interest-only loans with offset facilities could minimise investment costs over the loan period and provide readily available funds for other uses. This allowed them to gain certainty about their monthly expenses while still benefiting from cost minimisation.
By December 2018, APRA had removed the restriction on interest-only loans.
However, with ADIs required to carry more capital for this type of lending, the gap between interest-only and P&I investment lending rates and P&I investment lending rates widened.
As the market entered a low-rate cycle, many borrowers have since elected to take P&I repayments.
A new market with new challenges
Fast forward to 2023, and investors with one or two properties, who we often call “mum and dad investors”, now make up over 90% of all rental property owners in Australia, according to Field.
With the unanticipated rise in interest rates over the past 12 months, and the continuing increase in shortfall between rental incomes and mortgage costs, the impact is starting to hit household budgets.
While rent has risen in all markets around Australia, Field said it generally had not risen as much as mortgage costs and reducing the impact on the household budget was becoming a priority for mum and dad investors.
“With just under 30% of all new stock on the market reported as being generated from investor-owned listings, at Auswide Bank we are starting to see the pressures facing these investors,” Field said.
While it was still “very much a supply and demand” market with “strong” owner-occupier representation evident, Field said the importance of properties continuing to be available for rent to help accommodate everyday Australians could not be understated.
“With a large number of investment loans now on P&I repayments, as well as their owner-occupied mortgages, the challenge of balancing cashflow is becoming more and more evident and investors should be taking to time to review their strategies with their brokers, accountants and financial advisors.”
What strategies can brokers use for investor clients?
When it comes to guiding investor clients, brokers can implement various strategies to navigate changing market conditions and optimise their financial positions.
Aside from accessing lenders who offered discounted rates and offering offset accounts, Field said it ultimately came down to minimising cashflow impact.
“Consider reducing the cashflow pressure of P&I repayments on the investment lending by switching back to interest-only,” Field said. “This strategy will free up the principal that was being applied to the investment lending, allowing it to be utilised towards the increase in P&I repayments for any owner-occupied lending.”
In contrast, Syed said investors had been the “big winners” from the reduced serviceability buffer rate policy some lenders have implemented, making it easier for investors to cope with principal and interest.
“There is now real competition in this space, with more than five lenders offering this policy. Investors, particularly on high-rate non-bank loans, can swap to lower rate options by utilising these lower benchmarks. If they don't meet policy, fewer adjustments are required to pass serviceability,” Syed said.
“There are also serviceability improvements to non-bank lending options that can help reduce repayments too.”
Finally, Giardina said what all three agreed with – that the main goal was to make sure these clients were as “informed and prepared as possible”.
“We encourage them to review existing loans and determine if there are opportunities within the portfolio to refinance to a lower interest rate. We also recommend to budget and forecast for at least another one to two rate rises in the future,” Giardina said.
“It’s important to get really clear on what these expenses are going to look like and how it will affect their current cash flow position.”
