Interest Only Loans and Debt Servicing

Interest Only Loans have been favoured by homebuyers and property investors for many years as way of preserving cash flow.

(If you are not paying off principal, then you have more cash available for other purposes).

For property investors, not paying principal also has the advantage of higher interest deductions and as the debt is not being amortised.

However, whilst Interest Only Loans are still available, the approach by Lenders when it comes to assessing serviceability, has tightened over recent years.

Combined, both the factors can significantly increase the amount borrowers’ need to cover to demonstrate they can service the loan.

Lenders will typically add a Serviceability Margin of approximately 2.5% to a borrower’s actual interest rate.

They do this to confirm the loan can still be repaid in the event of future interest rate rises.

Alternatively, they may just use a Serviceability Rate of between 5.25% and 5.50%.

Whilst this may seem unfair given our current historical low rates, interest rates will increase at some point.  By adding a Serviceability Margin, Lenders are seeking reassurance the loan can be repaid in the event rates do increase.

The last thing Lenders want to do is to force borrowers to sell property because the debt can’t be serviced. When this occurs, everyone loses!

Whilst the approach taken in relation to rental income varies from Lender to Lender, rental income is often discounted by 20% for debt serviceability purposes.

The reason this is done is to allow for a period where the property may be untenanted.

If you would like to learn more don’t hesitate to give me a call.