Home loan truths: interest-only borrowers face $120bn time bomb

The nation’s love affair with interest-only home loans is set to come back to haunt it over the next three years.

The nation’s love affair with interest-only home loans is set to come back to haunt it over the next three years as hundreds of billions of dollars of these loans switch to having normal repayment schedules, leaving borrowers scrambling to refinance or sell.

About $120 billion worth of interest-only loans — about 7 per cent of the total value outstanding — is on track to convert to normal principle-and-interest loans over each of the next three years, the Reserve Bank has estimated.

Borrowers are facing a jump in annual repayments of between 30 per cent and 40 per cent, equivalent to $7000 a year for the “representative” borrower with a $400,000, 30-year mortgage with a typical five-year interest-free ­period. “This is a non-trivial sum for the household concerned,” Reserve Bank assistant governor Chris Kent said yesterday.

“Some interest-only borrowers may have to consider selling their properties to repay their loans,” he added in a speech that played down the likelihood of any impact on the broader economy.

“Some borrowers may experience genuine difficulties when their interest-only periods expire … but for the household sector as a whole the cash-flow effect of the transition is likely to be moderate,” he said, suggesting interest repayments would rise by the equivalent of 0.2 per cent to total household disposable income.

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The speech came amid regular falls in Sydney house prices, slowing price growth elsewhere and falling demand for home loans.

Brokerage Morgan Stanley yesterday forecast that home loan growth would slow significantly from 6 per cent to 4 per cent “given the combination of more onerous capital rules, tighter lending standards, higher mortgage rates and credit rationing”. But Morgan Stanley added that “risk is skewed to the downside given an increasing focus on responsible lending”.

Other analysts worry the royal commission into misconduct into financial services will further encourage lenders to tighten their standards.

Encouraged by tax advantages for debt-funded property investment, the share of interest-only loans had soared to almost 40 per cent of the total by value last year (the highest in the world), at the same time as the overall value of mortgages soared from $980bn a decade ago to about $1.74 trillion. Among investors, the share rose to 60 per cent.

In response to international and domestic concerns about the fragility of the exposure of Australian households and housing market to debt, regulators have progressively capped the growth of investor and interest-only lending since 2014, most recently limiting to 30 per cent the flow of new interest-only loans from the beginning of last year. “Many households have already switched willingly in 2017 in response,” the RBA’s Dr Kent said, noting regulatory efforts had pushed up interest rates on interest-only loans by about 0.4 percentage points.

“The combination of higher interest rates and tighter lending standards contributed to the share of new loans that are interest-only falling comfortably below the 30 per cent limit.”

Dr Kent was sanguine about any financial stability implications, suggesting the bulk of stressed borrowers could sell, refinance, or access other savings. “Around half of owner-occupier loans have prepayment balances of more than six months of scheduled payments,” he said.

The RBA’s biannual financial stability update last week pointed out that money in mortgage offset accounts exceeded $275bn. “The share of borrowers who cannot afford the step-up in scheduled payments and are not eligible to alleviate their situation by refinancing is small,” Dr Kent said.