Broker hits back at regulator crack down on interest-only loans

by Julia Corderoy11 Dec 2014
A broker has confronted both ASIC and APRA in defence of interest-only loans, after both regulators expressed concern over the rise in these types of home loans – suggesting this may be representative of a broader trend towards risky lending practices.

In a letter obtained by Australian Broker, Ray Weir, director of Finance Solutions WA, hits back at APRA and ASIC, saying there are many logical – and safe – reasons as to why a borrower takes out an interest-only loan.

One reason, according to Weir, is when it is an investment property and the interest is tax deductible. 

“…the principal amount is never intended to be amortised. The best advice to such borrowers is to utilise surplus cash flow to instead concentrate on repaying non-deductible ‘bad debt’ such as an owner-occupier home loan or other personal debt.”

When buying a property for owner-occupation, Weir says an interest-only loan can be beneficial if the borrower wants to minimise the monthly commitment before they intend to substantially reduce the loan. 

“This method of financing is often used by migrants wishing to buy their first home in Australia, before they sell their former overseas residence when the time is right. Anyone intending to make a sizeable reduction in a proposed new home loan within 12 months, for whatever reason, often request an interest only loan for the first year, with the subsequently reduced balance converting to lower principal and interest repayments after 12 months.”

Interest-only loans are never a long-term plan, says Weir, but can be a practical option in the short-term to free up cash for business purposes or other investment, or to accelerate the payment of other higher-interest rate debt. He also says it can actually help borrowers pay off their loan cheaper and faster.

A high income borrower can take out an interest-only home loan, but still make regular lump sum principal reductions. According to Weir, this will lead to a larger reduction in the monthly interest commitment when compared with fixed monthly repayments on a standard principal and interest loan.

Alternatively, if a young couple take out a ‘Parental Guarantee Loan’ – whereby they can avoid LMI by borrowing up to 80% in one loan and the remainder in a second, smaller loan using their parent’s property as security – then taking out an interest-only loan for the smaller loan will help them pay off the larger loan quicker.

“The primary loan would be repayable on the principal and interest basis over 30 years, while the second loan could be interest only, allowing accelerated repayment of the principal amount while consequently reducing the monthly interest commitment, thereby repaying that loan prematurely and thus releasing the parent’s property from security early,” the letter read.


  • by Marko 11/12/2014 9:03:52 AM

    Ray is quite right with his commentary. However these types of loans are in the minority and do not account for the rapid growth of interest only loans for owner occupiers.

    The risk is that these loans are being mis-sold to vulnerable borrowers. Consider the following scenario:
    1. Borrower takes out an interest only owner occupied loan at 90% LVR for 3 years.
    2. Rate is fixed for 3 years.
    3. At the end of three years the loan rate reverts to the prevailing variable rate, which has risen by 3% in the 3 year period.
    4. At the same time the borrower is now required to repay principle and interest.
    5. The borrower cannot afford the P&I repayments at the higher rate and seeks to refinance. However in the three year period property values have fallen by 10% and his LVR is now 100%. He cannot secure refinance for this reason and also because he cannot demonstrate his capacity to repay. The only way out is to sell the property at a loss.

    All of these conditions (increasing interest rates, falling property values) are very possible in the next 4 years in many markets.

    This exact scenario played out in the UK a few years ago with the result that lenders had billions of pounds in mortgages set aside by the regulator.

    Imagine the response of FOS, COSL or ASIC to a complaint by the borrower that the loan was unsuitable for them.

    Lenders test serviceability at a stress rate, yes and many also use the P&I repayment in their serviceability calculations. But we all know that most people will adjust their lifestyle to their surplus income and a repayment shock such as in the above scenario often leads to mortgage stress.

  • by AF 11/12/2014 9:29:16 AM

    Interest only loans for investors, especially those with non deductible debt is just good planning. This country is being dictated to by a public sector that is anti self sufficiency, anti innovation, in fact anti wealth accumulation. Why? Because they sit on their fat guaranteed salaries, guaranteed excessive superannuation benefits & have a total lack of understanding outside the PAYG regime. Governments are also to blame e.g. the FHOG qualification criteria. The only requirement to qualify for the various FHOG grants is to occupy the property for 6 of the first 12 months. Would this tempt any potential investors I wonder?
    If we allow ASIC & APRA to have their way, they will be the last ones left to turn out the lights. Perhaps they haven't given much thought to the fact that if they over regulate, there will be less wealth creation, less jobs, less tax & no money to pay their fat wages. Don't we still live in a democracy where freedom of choice still applies?

  • by Tom 11/12/2014 9:50:46 AM

    Sorry Marko, but I disagree. I sell quite a lot of Interest Only loans to Owner Occupiers, and it goes hand in hand with an Offset Account.

    If their salaries are directed into the Offset Account the balance should accumulate over the Interest Only period, just as it would if they were paying P&I.

    If however, their savings or lack thereof indicate they have trouble saving, then I use P&I to ensure they are getting ahead.

    It is a flexible solution tailored to each individual client - what suits and works for one, may not for another.

    That's our job - to structure appropriately for each individual clients circumstances and needs.

    That is what I classify as looking after the client, ASIC & APRA need to pull their head out of the sand, and stop trying to dictate a one solution fits all approach!