A borrower with an average interest-only loan of $316,000 will need to find an extra $400 a month to meet the higher principal-and-interest rates, according to analysis by Finder.com.au based on typical repayments.
For a $1 million borrower, the monthly repayments from switching to a principal-and-interest loan will blow out to about $880, its analysis reveals.
“Red lights are beginning to flash. It’s going to be a tough period for many property buyers,” said Graham Cooke, insights manager at Finder, who based his analysis on research published by the Reserve Bank of Australia and Australian Prudential Regulation Authority.
In some cases lenders are forcing buyers to make the move to principal-and-interest before the fixed-term loan rate expires.
Julie Klein, 64, who is paying off an apartment in Kew, a leafy inner-Melbourne suburb, said her lender demanded she switch to principal-and-interest after she lost her job because of health problems.
Ms Klein, who bought her apartment about nine years ago, said: “The bank basically told me it was going to happen and there was nothing I could do about it. I had been a loyal customer for more than 40 years and they basically told me that was ‘too bad’. I am too small for them to matter.”
Her options were to find another lender – which, without regular income, would be difficult – or sell in a market where prices are falling, particularly for apartments.
Mortgage renewals will flood into a lending market increasingly nervous because of falling prices, plunging auction clearance rates, weak income growth, falling rental demand in key markets and a flood of new apartments.
Investors – particularly those using their self-managed super funds – who purchased with small or no deposits, and off-the-plan buyers whose apartments are coming up for completion will also be under growing pressure.
An estimated 12 per cent of residential property investors with six or more holdings are also being targeted, particularly where rental income accounts for about 50 per cent of repayments.
Borrowers are facing tight lending terms and conditions being imposed by most lenders, which have introduced much more rigorous analysis of household income and expenditure under regulators’ responsible lending criteria.
Borrowers with good incomes that comfortably cover foreseeable household spending and with big deposits are highly coveted by all lenders, with special rates, bigger discounts and special cash incentives to cover switching or legal expenses.
But others are turning to shadow banks that are making it easier to qualify for a loan but often charge significantly higher rates, despite headline rates being more competitive then major lenders and other authorised deposit-taking institutions.
Into the shadows
Shadow banks, or non-authorised deposit-taking institutions, are typically offering principal-and-interest, owner-occupied loans at 52 basis points less than the major banks, or about 3.77 per cent for a $1 million loan at 80 per cent loan-to-value ratio, according to Canstar, which monitors rates and fees.
Shadow bank lending grew last year by nearly 16 per cent, or double the rate of the previous three years, according to analysis of RBA and APRA data by Digital Finance Analytics.
Their total share is close to 9.5 per cent and growing strongly as borrowers switch from mainstream lenders to get a better deal, or more competitive introductory rates.
In late 2016 the market share was just above 7 per cent.
“Banks will be trying to refinance as many as they can. But the alternative for many buyers will be to sell, or go to the non-banks,” said DFA principal Martin North.
“It is fair to conclude that non-banks are lending like fury compared with the ADIs. But this is a big thing for the python to swallow. This is a symptom of easy non-bank funding, different capital requirements and a greater willingness to lend.
“But it is also a sign of more trouble ahead. Some borrowers rejected by the banks because of not meeting the tighter lending standards are being swept up by the non-banks, where they will have to pay a higher interest rate.”
A borrower with an interest-only loan pays only the interest, which means monthly repayments are lower than principal and interest. They typically have a term of between one and five years.
About $706 billion of loans were written between 2014 and 2015, when property prices in major cities were fuelled by record low interest rates, easy credit and soaring optimism.
Loans coming up for expiration were approved when scrutiny of lenders’ motives and capacity to grow were less important than ADIs building market share, according to analysis.
But regulators imposed lending caps after warnings from the Reserve Bank of Australia about record levels of household debt increasing financial vulnerability to a change in personal circumstances or sharp economic correction.
Recent regulatory analysis found that fewer than half of borrowers have plans about how to repay the principal.
Mortgage brokers and analysts claim the removal of interest-only lending restrictions to ease an emerging credit squeeze won’t put a floor under falling house prices or kickstart investor credit growth.
They claim banks are continuing to tighten underwriting standards in response to expected recommendations from the Hayne royal commission and Reserve Bank of Australia record levels of domestic debt.
APRA chairman Wayne Byres recently said restricting interest-only home loans to 30 per cent of banks’ new mortgages, and the 10 per cent annual growth cap on lending to property investors, had “served their purpose of moderating higher-risk lending” and “supporting a gradual strengthening of lending standards across the industry over a number of years”.
Christopher Foster-Ramsay, principal of Foster Ramsay Finance, a mortgage broker, said: “The restrictions have been relaxed, but it has not made much of a difference.”
Lending products have changed in the past three to five years, which means borrowers have to undergo a new full reassessment of their financial circumstances, convert to principal and interest, pay off their loans in full, or find another lender.
“Lender scrutiny is forensic, serviceability is harder and there is more emphasis on income and expenses,” Mr Foster-Ramsay said.
For example, off-the-plan buyers with conditional loan approval are, on completion of the building, undergoing a formal property valuation and reassessment of their financial position prior to settlement.
In addition, some interest-only borrowers whose properties have fallen in value since taking out the loan are breaching the 20 per cent loan-to-value ratio, which means they are liable for expensive lenders’ mortgage insurance.
Mortgage brokers, who are an intermediary between lenders and borrowers, warn it will increase among buyers that have not been able to build equity because they bought at the peak of the market.