A look into borrower understanding of interest only loans has revealed brokers might be doing a better job than the banks at explaining them.
UBS Evidence Lab recently surveyed more than 1000 borrowers with questions about their mortgage and while more people seemed to know whether they had an interest only loan or not, their knowledge still “remains poor”.
According to the report, most borrowers took out an interest only loan for the extra flexibility or so they could maximise negative gearing.
A concern for the analysts at UBS was that 11% said they had chosen interest only because they hoped house prices to change and another 18% said they could not afford principal and interest (P&I).
The lack of understanding about interest only loans was made clearer when 32% of owner occupiers said they wanted to maximise negative gearing, despite this only being available to investors.
Also, some respondents did not know when their interest only period expired, with some owner occupiers believing it would last for more than 15 years when banks generally do not offer it for this length of time.
Comparing loans originated by brokers or banks, the data showed that borrowers were clearer on their interest only terms when taken out through a broker.
For instance, when asked when their interest only period expired, 5% of those who had borrowed through brokers said they did not know compared to 9% of those who had gone through a banker.
Also, when asked if they knew how much their payments would increase by after the IO period ended, 54% of those who went through the bank said they did not know. This was compared to 25% of borrowers who used brokers.
However, most borrowers across both originations were not fully aware of how much their repayments would step up, although those who had used brokers were closer to the actual figure.
The UBS analysis report, compiled by Jonathan Mott, Rachel Finn and Karyn Cao, said, “These findings concern us given that many borrowers, in particular Owner Occupiers with Interest Only mortgages, appear to have mortgage products that they do not fully understand.
“When Interest Only loans expire and revert to Principal & Interest, these customers are likely to face a financial shock when their mortgage repayment steps up by 30-60%.
“These customers are likely to have to pull back on their consumption in order to afford the substantially higher mortgage repayment, sell their property or could potentially end up falling into arrears.
“These findings also indicate to us that brokers and bankers still have more work to do to educate borrowers on different financial products and how these may affect their financial position.”