Interest only loans are a toxic ticking bomb for Australian economy

Interest only loans are a toxic ticking bomb for Australian economy
Jonathan ChancellorDecember 7, 2020

The Reserve Bank of Australian has again noted its concern about the borrowers who have have taken interest-only loans.

There are around 1.46 million interest-only (IO) mortgages.

Some commentators reckon these loans are the making of a localised crisis the equivalent not seen since the 2008 United States subprime disaster which triggered the global financial crisis. 

There's no doubting IO loans are potentially toxic or otherwise our regulators would not have hastened their recent crackdown.

The borrowers were initially tax minimising investors but a troubling number were then home buyers who took the cheapest borrowing route to upsize to the priciest home they could be calculated by their lenders to afford.

The RBA figures show around 30 per cent of mortgage debt as subject to the upcoming IO reset, with its peak in 2020.

The RBA estimates around $120 billion in IO mortgages will convert to back to the traditional principal and interest loans (P&I) every year between now and 2021.

The sting in the tail of these lower-repayments IO loans is that they apply for typically five years.

At the end of that period, the repayments step up as instead of paying the principal off over 30 years, borrowers will be repaying it back over 25 years.

When IO loans reset it is estimated repayments will leap for the borrower by between 30 to 40 per cent.

The Reserve Bank admits these resets are an "area of potential concern".

They anticipate most borrowers "should be able to afford the step-up in mortgage repayments" because they have accumulated substantial prepayments.

But I'm not as optimistic given the landscape has changed in regard to lending capacity rules along with the deterioration in price growth.

Given lenders have already increased the rate of the interest for exisiting IO loans, the RBA had noted switching out was underway voluntarily.

And already some banks have spotted a small increase in arrears among borrowers switching to P&I loans 

"Partly, this was borrowers taking time to adjust to the higher required repayments, but most subsequently returned to meeting their payments in full," the RBA acknowledged.

Because of the recent slowing in price growth, I'd suggest the prospect of negative equity could rear its ugly head just as borrowers wish to refinance, rather than cop the higher repayments.

Borrowers who bought before the tightening of lending criteria by the Australian Prudential Regulation Authority will no longer qualify for the same loan amount, due to serviceability issues.

So home owners and investors investors will face challenges rolling over or renegotiating their loans and holding onto their property, or property portfolio. 

Treasurer Scott Morrison anticipates APRA's restrictions have reduced high risk activity in his desire for a "soft landing" for the housing market and Australian economy.

For borrowers the time for reviewing, planning and managing household budgets starts now.

This article was first published in the Saturday Daily Telegraph.

Jonathan Chancellor

Jonathan Chancellor is one of Australia's most respected property journalists, having been at the top of the game since the early 1980s. Jonathan co-founded the property industry website Property Observer and has written for national and international publications.

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