By Victor Kumar
The Australian Prudential Regulation Authority (APRA) has introduced further measures to slow down property investment, but this time it is targeting interest-only lending.
Banks have been requested to limit interest-only loans to 30% of new residential mortgages.
And this is on top of previous measures to limit new lending to investors to 10 per cent growth.
The thing is, back in about 2000, quite a few lenders wouldn’t approve interest-only loans if your loan to value (LVR) ratio was above a certain percentage. They were also loading the interest rates if you chose to have an interest-only loan.
So, in a way, it feels like history repeating – although back then it was normal banking practice whereas now it is being forced upon lenders by the government regulator.
Also, in the early 2000s, the standard situation with some lenders was that investment loans would automatically have a higher interest rate as well as those that had higher LVRs.
The difference today is that historically the interest-only loan book across all residential mortgages was below 30%. Now, it is sitting at around 37 – 40% depending on who you believe, which is one of highest levels in the world.
Resetting the equilibrium
While there are some affordability issues in Sydney and parts of Melbourne, which may have prompted more interest-only loans in the past decade, prices in those two cities are still below somewhere like London, but in the UK the percentage of interest-only loans is still below the 30% mark.
In my opinion, something does need to be done to reset the equilibrium so I do agree with APRA’s recent action.
It needs to curb interest-only lending to a more sustainable level, however perhaps this needs to be more postcode based.
One of the ways that is already happening is that these types of loans are no longer being continually rolled over. Instead, once the current term expires most loans are moving to principal and interest terms, or being re-assessed as a full application if another interest only term is sought.
As I’ve written about before (Why investors need to understand the current lending landscape), the new lending environment is likely to affect multiple property owners because if a number of their loans move from interest-only repayments to principal and interest they may have issues with cash flow.
Some of the reasons for the increase in interest-only lending include the rise of investors in the market, as well as homebuyers in Sydney and Melbourne using these types of loans as a way of qualifying for finance for properties experiencing rampant price growth.
Another factor is that there is a lot more investor education in the marketplace today than there was even 10 years ago.
About 80 – 90% of investors are using interest-only loans these days because they are better educated about the best financial products as well as the various tax deductions.
In my experience, in the years gone by, I would have to do a lot more client education to show why interest-only loans were better than principal and interest ones.
Now, I’m probably only getting 1 in 100 clients who need that level of education.
Impact of new lending rules
It’s important to understand that the interest in interest-only loans is because successful property investment is all about maximising your cash flow.
So these types of loans allow you to hold multiple properties rather than just one or two.
However, with these new rules in play, it will be harder for people to qualify for loans.
Lenders will pick and choose their clientele and they’ll take the premium clients as interest only based on LVR and financial status. The rest will be forced into the principal and interest regime.
The reality is we don’t know how these changes will impact the market yet, because whenever these types of “levers” are pulled, it takes many months to weave their way through the sector.
Off-the-plan buyers, already struggling under tighter lending conditions, are likely to face the toughest challenges if they now have to qualify for a principal and interest loan instead of interest-only.
The lending future
Because there are markets at different phases of the cycle across the country, I would hope that these rules will be postcode restricted because some locations are hot and some are cold.
There is also no indication that the new rules will impact existing borrowers – unless they are moving from an interest-only to a principal and interest loan environment.
These lending restrictions should be seen as an opportunity rather than a threat.
Instead of doom and gloom, we need to work out what opportunities this will bring. For example, some investors who have had interest-only loans may not be able to afford principal and interest repayments and will be forced to sell. And we all know that forced sales can generally mean the chance to buy properties under market value.
There is no denying that the lending environment is becoming more difficult, so investors need to use a good broker who can find the lenders that will still offer interest-only loans.
If the only way that you can get a loan is by going principal and interest, so be it!
As long as you can afford the cash flow, don’t lose the opportunity to invest in good property just because you can’t get an interest-only loan.
By Victor Kumar