Over 900,000 IO loans to expire from this month

Financial services comparison site finder.com.au conducted an analysis of housing finance data from the Australian Bureau of Statistics (ABS) and found that more than 900,000 IO mortgage contracts are set to expire in January.

The comparison site found that out of $706 billion worth of new home loans approved in 2014-15, 42 per cent were interest-only ($295 billion), which is reportedly the highest on record in the last decade.

The Australian Prudential Regulation Authority (APRA) subsequently introduced measures to slow down the growth of interest-only loans. The restrictions saw IO loan approvals fall by 54.9 per cent, or $74.4 billion, in the 12 months to the end of June 2018, representing 16.2 per cent ($61.2 billion) of new home loan approvals. The regulator subsequently scrapped its IO cap in December.

While IO approvals are dropping, the demand remains strong, according to finder.com.au’s data, which shows that despite house values continuing on its downward slide and the RBA trying to discourage Australians from taking on riskier debt, nearly a quarter of investors and one in five owner-occupiers are seeking IO loans.

For those already in IO contracts, the switch to P&I could add an additional $400 a month to borrowers’ repayments (nearly $5,000 per year), based on recent interest rates. The figure could be higher if further rate hikes are introduced by the banks.

The Reserve Bank of Australia (RBA) painted a slightly grimmer picture earlier in the year when it warned that borrowers of IO home loans could be required to pay an extra 30 per cent to 40 per cent in annual mortgage repayments – or an additional “non-trivial” sum of $7,000 a year – once they’re reverted to P&I.

The central bank noted that the increase would make up 7 per cent, or $120 billion, of the total housing credit outstanding.

RBA assistant governor Christopher Kent in April said the cash flow effect of the transition would likely be “moderate” and was confident at the time in borrowers’ ability to manage the rise in mortgage repayments — claiming that many would service their mortgage using savings they’ve accumulated, through offset or redraw facilities, or by refinancing.

However, as credit criteria become increasingly stringent in the aftermath of the Hayne royal commission, IO borrowers may have difficulty obtaining another loan with similar repayments.

As financial services comparison site Mozo claimed in July, there is a growing league of “mortgage prisoners” in Australia who are unable to negotiate or refinance their home loans due to tighter lending criteria around income and expenses.

According to Mozo, the growing population of mortgage prisoners is partly a result of banks previously applying a “one-size-fits-all” approach to assessing a borrower’s income and expenses. “Modest” expenses had been estimated regardless of the borrower’s income, which led to “inflated amounts being lent to hopeful home buyers”.

Digital Finance Analytics estimated that, as of August, 996,000 households were experiencing mortgage stress, unhelped by subdued income growth, interest rate hikes and high costs of living.

Statistics from the National Debt Helpline, a free independent service launched in 2011 for Australians experiencing financial difficulty, showed that the helpline received more than 120,000 calls from January to August this year, up from 115,000 calls during the same eight-month period in 2017 and the highest ever for this period historically.

Further, the Salvation Army’s financial counselling service, Moneycare, also revealed seeing an 18 per cent increase in Australians requesting help, particularly those over the age of 55 and in “severe debt” (where the total sum of their loans are more than six times their annual disposable income).

On top of this, according to comparethemarket.com.au’s Financial Consciousness Index, which involved a survey of 3,000 Australians nationwide in conjunction with Deloitte Access Economics, 68 per cent of mortgagors have not stress tested their home loan.

“This is a particular worry when recent estimates show that a 0.5 per cent increase from current interest rates would cause mortgage stress to jump from one in four mortgaged households to one in three – a 2 per cent increase throws half of all mortgaged households into stress,” the report noted.

Opportunity for smaller lenders

Increasing pressures on mortgagors could ramp up the growth of smaller, non-bank, community-owned, and specialist lenders.

Recent ANZ Bank data showed that new mortgage issuance by non-bank lenders has risen by approximately 13 per cent over the year in the 2017–18 financial year, compared to 4.8 per cent growth for banks, taking the non-banks’ share of total housing debt from 6.6 per cent to 7.7 per cent.

ANZ economists Daniel Gradwell and Shaurya Mishra described the increase as a net positive, speculating that non-bank lenders “are making the most of their position outside of APRA’s regulatory net”.

Four separate analysis pieces from each of the “big four” accountancy and business consultancy firms — Deloitte, EY, KPMG and PwC — have noted that competition from non-major banks and non-bank lenders was having a marked impact on the big four banks’ market share and growth.

One firm even stated that “if non-banks continue to grow at this rate, regulators will need to keep a close eye on the implications for the system”.

[Related: APRA scraps interest-only cap]