Market conditions have changed, and many borrowers are finding Banks are reluctant to renew interest only loans.
During the property boom, it was common for borrowers to put all, or part of their financing, on an interest only basis.
This applied particularly to property investment.
Why it is harder to renew Interest Only Loans!
According to the Reserve Bank of Australia in 2014, Interest Only Loans accounted for approximately 40% of all mortgages.
Around this time the Australian Prudential Regulation Authority (APRA) instructed Banks to:
- Reduce the amount of interest only facilities as a percentage of their overall mortgage lending
- Place far greater scrutiny on customers’ ability to service their borrowings
- Use a serviceability interest rate buffer of at least 2%
- Ensure customers had the capacity to repay the borrowing, as a normal home loan, over the remaining term after the interest only period had expired. (In practical terms this means if a customer had an interest only loan for 5 years, they would need to demonstrate they could fully repay the loan over 25 years).
The impact of the changes has been dramatic!
In 2017 APRA again tightened the standards:
- Instructing the Banks to limit interest only lending to 30% of total mortgage lending
- And heavily scrutinize borrowings which had a high loan to security ratio
The impact of this changed approach has been quite dramatic in a number of ways:
- The % of interest only loans has reduced to almost 30%
- Interest only loans are far harder to obtain
- Banks now assess the debt servicing capacity of borrowers in granular detail
What this means if you have an interest only loan
Many borrowers have already voluntarily switched from interest only to an amortising loan. This in part being due to the higher interest rates applied to interest only borrowings.
If you have interest only facilities yet to expire, it is important to plan ahead and fully explore the options available.
The likelihood is that once your interest only period has expired, you will be asked to convert to an amortising facility.
Ability to service and repay are key criteria!
In the past, if you had a lot of equity serviceability was not such an issue for Banks. (You still needed to demonstrate serviceability however less detail was required)
However today that has all changed.
Regardless of the equity you hold in a property, you need to:
- Complete a monthly budget clearly demonstrating you can comfortably cover all your livings expenses and debt service obligations
- Provide supporting evidence (Payslips and Bank and Credit Card Statements) to validate the detail in your budget!
Plan ahead and prepare a budget
Given this new reality, we suggest preparing a budget well in advance of submitting the loan application.
That way, if you have to trim your monthly expenses, it will:
- Allow time to more fully investigate available options – work out what is feasible
- Provide evidence to the Bank (via Bank and Credit Card Statements) the expenditure in your budget, is based on lived experience.
What you can do if serviceability can’t be demonstrated
In the event you are unable to meet this more stringent criteria, you may need to:
- Explore alternate forms of lending from outside the mainstream providers (Low Doc Lenders and the like)
- Reduce debt to more manageable levels through the sale of assets
This latter step is never easy, but it is far more palatable than being placed in a position where you are forced to by the Bank. A “no win” situation for everyone involved!
The more stringent criteria adopted by Banks at the direction of APRA, has meant interest only loans are now harder to obtain and renew.
That said, options do exist and amortising borrowings whilst interest rates remain at historically low levels is a positive and prudent step. The key is to plan ahead.
If you would like to learn more and explore the options available, don’t hesitate to give me a call on 0421 304 990