Interest Only

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<div>EXPERT OBSERVER</div>
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<div>It looks as though tighter deposit requirements have run their course. </div>
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<div>Although December 2018 was a horrible quarter for mortgage lending in the lead-up to the end of the Royal Commission, the squeeze on loan-to-value ratios looks to be just about done. </div>
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<div>There are relatively few interest-only (IO) mortgages being written now, and this squeeze also looks to be about done. </div>
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<div>It's a smaller share of a smaller pie, and this is reducing household debt ratios as we speak (contrary to the incorrect claims you might read elsewhere). </div>
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<div>The ADI stock of outstanding IO loans is now less than ¼ of mortgages by value, the lowest on record across the data series. </div>
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<div>This may sound a lot, but most IO loans revert to principal repayment relatively quickly, and anyway IO mortgages can make a lot of sense for borrowers with offset accounts. </div>
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<div>Many borrowers have opted to revert to principal repayment early for the cheaper mortgage rates on offer. </div>
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<div>There was previously some debate surrounding what constituted a 'new' IO loan, but the interest-only 'cliff' is no longer a thing, since any mechanically forced reset no longer applies. </div>
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<div>It's in nobody's interests to see stressed borrowers go into arrears, so the reset should now be managed comfortably enough.</div>
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<div><strong>Left the building</strong></div>
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<div>It's interesting to note that partly thanks to switching across to cheaper rates, interest repayments have now declined to sit well below 10 per cent of household disposable income, down from 16 per cent a decade earlier.</div>
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<div>This is a very significant decline, and this hugely improved level of mortgage serviceability partly accounts for why mortgage arrears remain so low. </div>
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<div>Betwixt the Council of Financial Regulators and the Reserve Bank today the respective authorities confirmed today that there would be no further tightening of lending standards required, instead perhaps implying that banks rather need to write some business.</div>
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<br><strong>From the RBA:</strong>
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<div><em>"From a financial stability perspective, prudent lending standards are a good thing. They ensure that households and banks are resilient to changes in circumstances. </em></div>
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<em>But there needs to be a balance. </em><em>The regulators are not proposing any further tightening in lending standards. </em>
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<div><em>And the appropriate amount of credit risk is not zero – banks need to continue to lend and that will inevitably involve some credit losses."</em></div>
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<div>Welcome news, while fixed mortgage rates are being cut widely as funding costs have declined. </div>
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<div>The regulators have left the building (for the time being!). </div>
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<em>PETE WARGENT is the co-founder of AllenWargent property buyers (London, Sydney) and a best-selling author and <a href="https://petewargent.blogspot.com/" target="_blank">blogger</a>.</em> </div>
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Interest-only cliff: no longer a thing - Pete Wargent

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<div>In August 2017 I attempted to estimate the value and timing of forced interest-only ('IO') resets as a result of tighter lending standards. </div>
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<div>Since that time many rational borrowers have elected to switch to principal and interest (P&amp;I) loans to benefit from the more attractive mortgage rates on offer. </div>
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<div>APRA's quarterly ADI figures showed that the flow of new IO loans was under 16 per cent for a second consecutive quarter. </div>
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<div>This dynamic combination has had a marked impact on the stock value of outstanding IO loans, declining by $93.2 billion of 16.1 per cent year-on-year.</div>
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<div>As a share of ADI residential term loan exposures IO loans have therefore been reduced to 31 per cent as at March 2018, well down from close to 39 per cent a year earlier. </div>
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<div class="separator"><img src="https://1.bp.blogspot.com/-8ZXOTXlNodQ/Wy8El82AoVI/AAAAAAAAqwI/Ksa4JePKI1oQlWmiti6A7-46KuZ3uYeugCLcBGAs/s640/APRA1.jpg" width="640" height="374" data-original-height="803" data-original-width="1367"></div>
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<div>Most borrowers appear to be handling the switch comfortably.</div>
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<div>Those most impacted are likely to be portfolio investors, although many of this cohort built their portfolios over a long period of time, building equity and cashflow in doing so. </div>
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<div>Some may have to sell a property or two in order to reduce debt. </div>
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<div>The share of higher loan-to-value (LVR) ratio lending continued to tighten in the March quarter, having already declined considerably since 2014. </div>
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<div class="separator"><img src="https://1.bp.blogspot.com/-xenupVlmdH4/Wy8El_m7iWI/AAAAAAAAqwQ/-WTHJbrtXA4wGT7M1HI2xxF-dGZjeU-_ACEwYBhgL/s640/APRA2.jpg" width="640" height="366" data-original-height="790" data-original-width="1378"></div>
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<div>The latest figures relate to the first three months of 2018, so it's difficult to know whether the Royal Commission had any further impact over the following period through to June.</div>
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<div>It's interesting to note that the major lenders have lost some market share over time.</div>
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<div>Yet bank share prices saw a punchy rebound this week, possibly relating to a short squeeze, or more likely a pervading sense of relief as the media loses its appetite for daily stories from the Royal Commission. </div>
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<span>PETE WARGENT is the co-founder of AllenWargent property buyers (London, Sydney) and a best-selling author and </span><a href="https://petewargent.blogspot.com/" target="_blank">blogger</a><span>.</span>
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Most IO borrowers handling the switch to P&I comfortably

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The limits of interest-only lending: RBA's Christopher Kent

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<p>GUEST OBSERVATION</p>
<p>Australian taxpayers won’t face a rise in taxes now that Treasurer Scott Morrison announced the government will not increase the Medicare Levy by 0.5% as planned. This was to originally fully fund the National Disability Insurance Scheme (NDIS).</p>
<p>This is on the back of strong company tax receipts stemming from companies using up carry-forward losses accumulated in the wake of the financial crisis.</p>
<p>Australian Bureau of Statistics data for 2016/17, released this week, showed tax revenue for the federal government (including taxes received from other levels of government and public corporations) increased A$19.4 billion (5.2%).</p>
<p>The averted tax rise will be welcome news for Australian taxpayers. It also wedges the Labor opposition.</p>
<p>They have said that the NDIS was fully funded on their watch. So now they are proposing a 0.5% tax rise on all incomes over A$87,000. That’s pretty close to full-time male average weekly earnings and comes close to capturing half of Australian households.</p>
<p>The federal budget on May 8 will no doubt have further goodies for voters in the run-up to the net election, which will be either this year or relatively early next year. As usual, we will be reporting directly from the budget lockup.</p>
<p>One of the central economic puzzles of the last several years has been persistently low inflation in all advanced economies, despite general economic recovery and falling unemployment.</p>
<p>This week’s Australian consumer price inflation figures revealed a 0.4% increase for the March quarter, and 1.9% for the last 12 months. The March quarter figure was below market expectations of 0.5%, and also the previous (December quarter) figure of 0.6%. Education prices were up 2.6% on the quarter, and health prices up 2.2% (or 4.2% for the year to March 2018).</p>
<p>This puts inflation still below the Reserve Bank of Australia’s (RBA) target band of 2-3%. That band, of course, has been in place since the early 1990s – beginning with this speech by then governor Bernie Fraser.</p>
<p>Numerous central banks around the world have a similar approach. The basic idea is that a central bank can build a reputation over time to commit to monetary policy such that inflation lies in the band.</p>
<p>Now there are pros and cons to this approach to monetary policy, and it has its critics. But that is another tale for another day.</p>
<p>Just assuming that inflation targeting is the correct objective, how is the RBA doing? Well, one small hitch in the plan is that inflation has been outside the band for a long time now (basically since 2014), as the RBA’s own figures show.</p>
<p>Given the level of unemployment in Australia, low wages growth, and stubbornly low inflation, the RBA probably should have cut rates further a fair while back. But they seem, probably rightly, terrified of further fuelling a potential housing bubble.</p>
<p>Meanwhile, the credibility of their commitment to the inflation target withers. If only the regulation of our banking and finance sector had been better for the last, say, decade or two.</p>
<p>Speaking of such regulation, RBA assistant governor Chris Kent gave a speech Tuesday about the important issue of interest-only loans. Kent’s speech was significant because it followed up on remarks in the RBA minutes about the same issue that I discussed in this column last week.</p>
<p>It seems that the RBA “house view” on interest only loans is as follows. There could be a problem but the Australian Prudential Regulation Authority (APRA) stepped in and the banks have voluntarily tightened lending standards recently. Also because the <em>average</em> household with an interest only loan has a buffer of savings, everything will be fine. Nothing to see here.</p>
<p>I hope the RBA’s conclusion is right, but I know for sure that the reasoning is not. It’s actually the <em>marginal</em> household’s financial position and behaviour that matters, not the average household.</p>
<p>The average United States borrower with an adjustable-rate mortgage did not default in 2007, 2008 or 2009. But these mortgages were a huge contributor to the financial crisis, along with subprime mortgages.</p>
<p>Kent dutifully laid out the risks from interest only loans, saying:</p>
<p>"Because there’s no need to pay down principal initially, the required payments are lower during the interest-only period. But when that ends, there is a significant step-up in required payments (unless the interest-only loans are rolled over)."</p>
<p>Indeed, unless they can be rolled over. Which they can’t now because of APRA and the banks finally doing something.</p>
<p>Now, prices (interest rates) on interest only loans have gone up as part of the bank response. This has led a bunch of folks to shift to amortising loans, where the principal of the loan is paid down over the life of the loan. So those borrowers who haven’t shifted to these loans already, really don’t want to.</p>
<p>Maybe they can’t afford to because of the increased repayments, that can jump 30% or more per month.</p>
<p>So what does happen? First Kent says many borrowers save ahead of time, expecting a rise in repayments. Yes, the prudent ones.</p>
<p>But how many non-prudent borrowers have there been in the Australian property market in recent years? Hint: a lot.</p>
<p>Kent also points to borrowers who seek to refinance their interest only loan. But banks don’t really want to, and APRA doesn’t want to let them. And who is going to be able to? The safer borrowers who did save and so don’t really need to avoid amortisation. The risky borrowers can’t refinance.</p>
<p>Kent says some borrowers will have to cut their spending. Chuckle, chuckle. And the final option is to sell their house.</p>
<p>Sure, no problem, unless lots of folks want to do that all at once. Then it’s a fire sale that detonates the housing market.</p>
<p>I really do hope we escape the interest only debacle unscathed. But if we do it will be pure, dumb luck, not a consequence of good design or sound regulation.</p>
<p>It definitely doesn’t justify the RBA’s house view in Kent’s concluding remarks that: </p>
<p>"The substantial transition away from interest-only loans over the past year has been relatively smooth overall, and is likely to remain so. Nevertheless, it is something that we will continue to monitor closely."</p>
<p><img src="https://counter.theconversation.com/content/95518/count.gif?distributor=republish-lightbox-basic" alt="The Conversation" width="1" height="1">Perhaps a there should have been a little more monitoring before interest only loans got to be 40% of all loans and more than half of the loan book of one of our biggest banks.</p>
<p><em><strong>Richard Holden</strong>, Professor of Economics and PLuS Alliance Fellow, UNSW</em></p>
<p><em>This article was originally published on <a href="http://theconversation.com" target="_blank">The Conversation</a>. Read the <a href="https://theconversation.com/vital-signs-interest-only-loans-are-an-economic-debacle-that-could-bust-the-property-market-95518" target="_blank">original article</a>.</em></p>
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Interest only loans are an economic debacle that could bust the property market: Richard Holden

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<p>Westpac has denied an AFR report it is giving risky property investors less than a month to find another lender.</p>
<p>The bank is alleged to be sending a single-page letter to investors warning it can "no longer support our commercial relationship with you."</p>
<p data-gtm-vis-first-on-screen-7770372_137="3688" data-gtm-vis-total-visible-time-7770372_137="4000" data-gtm-vis-has-fired-7770372_137="1">Victor Kumar, a director of Right Property Group, a buyers' agency, reportedly has seen the letter sent to property investors.</p>
<p>The letter informs borrowers that Westpac is a responsible lender.</p>
<p>Martin North, principal of Digital Finance Analytics, has reportedly been in contact with borrowers who have received the letter.</p>
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<p>Westpac denied the claims. </p>
<p>Initially Westpac said it was attempting to locate the letter and declined to comment.</p>
<p>"We don't support the claims made regarding the Westpac customer communications," a spokesman later told the AFR.</p>
<p>"Based on the limited information we have been provided, the statements made are incorrect."</p>
<p>As banks are forensically examining their lending books, the Westpac letters are reportedly being sent to interest-only borrowers with multiple properties and high loan-to-value ratios, usually 80 per cent or above.</p>
<p>The investors, who often have up to six properties, have been told they have until October 20 – or less than a month – to find a new lender.</p>
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Westpac denies risky property investors are being given one month to find alternate finance

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<p><span>The Australian Securities and Investments Commission has released a handy guide to interest-only loans for property inv</span>estors.</p>
<p>According to ASIC, <span style="line-height: 1.3em;">one in four loans are interest-only for owner-occupiers and two in three loans are interest-only for investors.</span></p>
<p><a href="/images/2015/10/09/Screen%20Shot%202015-10-09%20at%209.59.00%20AM.png" target="_blank">Click to enlarge</a></p>
<p><img src="/images/2015/10/09/Screen%20Shot%202015-10-09%20at%209.59.00%20AM.png" alt=""></p>
<p>According to ASIC, before applying for an interest-only mortgage, potential investors need to understand if they can <span style="line-height: 1.3em;">afford the higher repayments when the interest-only period ends, w</span><span style="line-height: 1.3em;">ill the short-term benefits outweigh the long-term costs and if you c</span><span style="line-height: 1.3em;">an be trusted not to dip into the offset account?</span></p>
<p><a href="/images/2015/10/09/interest-only-loans-infographic-part-1_942x2142.jpg" target="_blank">Click to enlarge</a></p>
<p><img src="/images/2015/10/09/interest-only-loans-infographic-part-1_942x2142.jpg" alt=""></p>
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<p><a href="/images/2015/10/09/interest-only-loans-infographic-part-2_940x1292.jpg" target="_blank">Click to enlarge</a></p>
<p><img src="/images/2015/10/09/interest-only-loans-infographic-part-2_940x1292.jpg" alt=""></p>
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<p><a href="/images/2015/10/09/interest-only-loans-infographic-part-3_944x1793.jpg" target="_blank">Click to enlarge</a></p>
<p><img src="/images/2015/10/09/interest-only-loans-infographic-part-3_944x1793.jpg" alt=""></p>
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<p>ASIC has also released a calculator to help potential investors work out three key factors behind an <a href="/expert-insights/finance/46711-asic-releases-interest-only-mortgage-calculator" target="_blank">interest-only mortgage</a>, as well as a a checklist for property investors considering <a href="/expert-insights/finance/46860-are-interest-only-mortgages-in-your-interest-asic" target="_blank">interest-only payments for mortgages</a>.</p>
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ASIC's interest-only guide for property investors

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<p>ASIC has produced a checklist for property investors considering interest-only payments for mortgages as well as a case study and various toolkits.</p>
<p>The self-check website outlines risks associated with interest-only loans, the benefits and offers other tips and advice.</p>
<p>For more information, <a href="https://www.moneysmart.gov.au/borrowing-and-credit/home-loans/interest-only-mortgages" target="_blank">click here</a>.</p>
<p><span>ASIC has also provided a handy tool for interest-only mortgage calculations, <a href="/expert-insights/finance/46711-asic-releases-interest-only-mortgage-calculator" target="_blank"><span>which you can find here</span></a>, as well as a handy guide to interest-only loans for property investors <a href="/expert-insights/finance/46852-asic-interest-only-guide-for-property-investors" target="_blank"><span>available here</span></a>.</span></p>
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Are interest-only mortgages in your interest? ASIC

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<p>Westpac is reducing the maximum allowable interest-only term for investment property loans to 10 years.</p>
<p>The interest-only term could previously be extended to 15 years, according to brokers. </p>
<p>In addition, the 12-year fixed rate investment property loan and its low documentation equivalent will no longer be available.</p>
<p>In August last year Westpac tightened its credit policies for interest-only mortgages, given it was an emerging area where financial regulators have raised concerns about bank underwriting standards.</p>
<p>The country's biggest lender to landlords told brokers of changes in August last year requiring new interest-only borrowers to be tested against their ability to make principal, and interest and fees payments over the "residual" period of the loan after the interest-only period had ended.</p>
<p>In May last year the Australian Prudential Regulation Authority chairman Wayne Byres singled out interest-only as a concerning issue.</p>
<p>He said that if a borrower sought a 30-year loan with a five-year interest-free period, only a minority of banks assessed the borrower's ability to make principal and interest payments over the remaining 25 years.</p>
<p>This was the approach Westpac was adopting.</p>
<p>Instead, Mr Byres said that "despite the contractual terms", most lenders assumed the borrower would make principal and interest payments over the full term of the loan.</p>
<p>This assumption allowed banks to "inflate the hypothetical borrower's apparent surplus income by, in our particular example, around 5 per cent", Mr Byres said.</p>
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