Interest-only borrowers facing credit crunch, analysts fear

Borrowers holding about $400 billion worth of interest-only loans are set to face a tight squeeze on their household incomes.

Analysts fear an interest-only loans credit crunch is just around the corner.

Borrowers holding about $400 billion worth of interest-only loans are set to face a tight squeeze on their household incomes, in further evidence put forward by analysts concerned about the likelihood of a credit crunch in the Australian economy.

Morgan has joined UBS with a renewed warning of a credit crunch, arguing that heavily indebted borrowers will have to ­devote a further 15 per cent of their take-home salary to mortgage repayments over the next five years as interest-only borrowers face a forced switch to loans with principal-and-interest repayments. Monthly loan repayments usually jump by up to 50 per cent when switching from interest-only to principal and interest.

“The step-up in repayments … is well known,” Morgan Stanley analyst Richard Wiles said. But he said what was “more concerning” was that disposable income for a borrower with debts four times as large as their income could fall by 10 percentage points. For borrowers in debt more than six times income, disposable income would fall 15 percentage points — leaving them devoting 60 per cent of their pay cheque to paying off their mortgage. Those on loans with debt-to-income levels of four times would be paying 40 per cent of their pay towards the mortgage.

“We think the consumer is facing a cash flow and credit crunch,” Mr Wiles said, pointing to weak income growth, cost of living inflation, tighter credit conditions and interest-only switching, which he said would put pressure on discretionary spending and household saving.

Interest-only loans, which do not require payment of the mortgage’s principal amount, have been increasingly targeted by regulators. The Australian Prudential Regulation Authority last year forced the banking sector to limit interest-only lending to 30 per cent of all new loans, down from about 45 per cent at the time.

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Many borrowers entered into interest-only mortgages not long before APRA began to force banks to lift lending standards.

The bulk of these loans are expected to mature in 2020, which worries analysts because of the likely inability of many of these borrowers to repay the loans if they cannot refinance on an interest-only basis.

Lending is already starting to display signs of a potential credit crunch as official statistics showed borrowing for the housing market fell to its slowest rate in five years.

Analysts at investment bank UBS have warned of a “disorderly” housing correction as the risk of a credit crunch rises.

UBS analyst Jonathan Mott told investors the habit of lower-quality borrowers leaving the major banks and sourcing credit from the unregulated shadow market was no longer a “sustainable” situation.

“We are concerned that a regulatory mismatch has been created, whereby the focus on lending standards and complying with responsible lending is heavily skewed towards the major and regional banks,” Mr Mott said.