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Interest-only borrowers face $7,000 mortgage hike: RBA

Borrowers approaching the expiry of their interest-only home loans period could be required to fork out an additional $7,000 a year, according to the Reserve Bank.

In his address to the Housing Industry Association breakfast in Sydney on 24 April , RBA assistant governor (financial markets) Christopher Kent noted that an interest-only (IO) borrower with a $400,000, 30-year loan with a five-year interest-only period could be faced with a 30 per cent to 40 per cent increase in mortgage repayments.

“Because there’s no need to pay down principal initially, the required payments are lower during the interest-only period. But when that ends, there is a significant step-up in required payments,” Mr Kent said.

“This owes to the need to repay the principal over a shorter period; that is, over the remaining term of the loan. Also, because the debt level is higher over the term of the loan, the interest costs are also larger.”

The RBA assistant governor added that the “non-trivial’ step-up in mortgage repayments would make up 7 per cent ($120 billion) of the total housing credit outstanding.

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Mr Kent warned that such risks would have an adverse effect on borrowers and lenders alike, with some borrowers particularly at risk in the event of a “shock” to the broader Australian economy.

“If the borrower has made no provisions and is unable to make the necessary adjustment, they may need to sell the property to repay the loan. Therein lies an additional risk inherent in interest-only lending.

“Moreover, the borrower's ability to service the loan is not fully tested until the end of the interest-only period.

“If the borrower defaults, the potential loss for the lender will be larger than in the case of a P&I loan, given that interest-only loans by design allow borrowers to maintain the debt at a higher level over the term of the loan.”

Mr Kent also echoed a view expressed by ratings agency Standard and Poors (S&P) that owner-occupier borrowers are exposed to greater risk than investors following the expiry of the IO term.

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“The most vulnerable are likely to be owner-occupiers, with high LVRs, who might find it more difficult to refinance or resolve their situation by selling the property,” Mr Kent said.

However, the assistant governor observed that the impact of such risks would be “moderate”.

Mr Kent noted that he was confident in borrowers’ ability to manage the rise in mortgage repayments, claiming that many borrowers would service their mortgage using savings they’ve accumulated, through offset or redraw facilities, or by refinancing.

“For the household sector as a whole, however, the cash flow effect of the transition is likely to be moderate,” Mr Kent added. “The effect on household consumption is likely to be even less.

“This is because some interest-only borrowers will be willing and able to refinance their loans. Also, many others have built up a sufficient pool of savings, or will be able to redirect their current flow of savings to meet the payments, or have planned for, and will manage, this change in other ways.”

Mr Kent also stressed the importance of lending curbs introduced by the Australian Prudential Regulation Authority (APRA).

“The observation that the transition is proceeding smoothly is not an argument that the tightening in lending standards on interest-only loans was unwarranted — far from it.

“The tightening in standards starting in 2014 has helped to ensure that borrowers are generally well placed to service their loans.

“And the limit on new interest-only lending more recently has prompted a reduction in the use of those loans during a time of relatively robust growth of employment and still very low interest rates.

“In this way, it has helped to lessen the risk of a larger adjustment later on in what could be less favourable circumstances.”

[Related: Owner-occupiers at greater risk than investors: S&P]

Interest-only borrowers face $7,000 mortgage hike: RBA
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Charbel Kadib

Charbel Kadib is the news editor on the mortgages titles at Momentum Media.

Before joining the team in 2017, Charbel completed internships with public relations agency Fifty Acres, and the Department of Communications and the Arts.

You can email Charbel on: This email address is being protected from spambots. You need JavaScript enabled to view it.

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