Banks concerned over switch out of ‘interest only’ loans

A rise in the number of customers switching from interest-only to principal and interest loans was a concern for the banks.

The reprieve for interest-only customers came after the banks were slammed in 2018 for using an APRA crackdown on interest-only loans as an excuse to hike rates, a move that saw them pocket an extra $1.1bn in revenue over the year. Picture: Jenny Evans

A rise in the number of customers switching from interest-only to principal and interest loans was a source of concern for the nation’s major lenders last year, with at least one bank going harder on rate cuts in its more profitable interest-only product to try and stem the leakage, according to the competition regulator.

In January 2019, the average variable rate across the big banks for owner-occupiers on principal and interest loans sat at 4.31 per cent, while investors with interest-only loans were paying 5.13 per cent, on average.

By October, after the Reserve Bank had cut rates three times in the space of five months, principal and interest rates had fallen 66 basis points to 3.65 per cent, while interest-only borrowers had seen their rates slashed 75 basis points to 4.38 per cent.

“At least three banks were concerned about the impact on their margins of customers switching from higher margin interest-only loans to lower margin principal and interest loans,” the ACCC found in its inquiry into home loans at the big four banks which was released this week.

“The big four banks reported that a number of their interest-only customers had refinanced to principal and interest loans during the price monitoring period (January to October 2019).”

The large gap between the variable rates on principal and interest loans versus interest-only loans may have been one cause of the switching, the regulator said, “leading to at least two banks wanting to reduce the differential”.

One bank told the regulator that its rate moves across its home loan products last year were partly aimed at making interest-only loans more attractive to limit the number of customers switching to lower margin principal and interest loans, “to help reduce ‘margin compression’”.

The reprieve for interest-only customers came after the banks were slammed in 2018 for using an APRA crackdown on interest-only loans as an excuse to hike rates, a move that saw them pocket an extra $1.1bn in revenue over the year.

The banking regulator imposed a limit on interest-only lending in 2017 to take the heat out of the housing market, requiring lenders to limit the flow of interest-only loans to 30 per cent of new residential mortgage lending. The limit was lifted in early 2019. In response to the new limit rules, ANZ in March 2017 hiked rates on its investor home loans, with its peers following suit.

“Despite the interest-only benchmark applying only to new interest-only residential mortgages, the inquiry banks (the big four plus Macquarie) all followed ANZ’s decision to increase interest rates for both new and existing interest-only residential mortgages,” the ACCC noted in its 2018 inquiry into the banks.

“We consider that the (APRA) benchmark provided the opportunity for the banks to synchronise their significant increases to interest-only rates during the price monitoring period, at a significant cost to those borrowers,” the competition regulator said.

In its latest findings, released on Monday, the ACCC noted that the banks had more room to move on interest-only loans in 2019 because of the hikes following the APRA-imposed limits.

“As one of the big four banks noted, investor interest-only loans have ‘been disproportionately impacted by historical back book reprices’,” the ACCC report said.

Josh Frydenberg tasked the ACCC with taking a closer look at residential lending practices within the big four banks in 2019 after the lenders failed to fully pass on RBA rate cuts and amid controversy over a so-called “loyalty tax” existing customers were paying in the form of higher rates on their home loans.

Alongside its findings on interest-only loans, the interim report also found that the major lenders kept profitability front of mind when considering interest rate moves, but also considered the potential political fallout and were slow to pass on rate cuts, with one bank taking into account the additional revenue it would make by delaying headline rate changes.

The final report, which will look at difficulties customers face when refinancing to new lenders, will be released later this year.