Due to changes from the banking regulator, APRA, interest only loans are becoming costly.
Do you make interest only payments on your home loan and want to know more about why your interest rates have crept up in recent months?
Traditionally interest only repayments were used as a tax-effective debt reduction strategy for investors. But in recent years an increasing number of both investor and owner occupier borrowers have adopted this repayment option to make their loans more affordable.
The Australian Prudential Regulatory Authority (APRA), have examined the amount of interest only loans held by Australian banks, which is believed to be one in four owner-occupier loans and two thirds of investment loans, and flagged this as a risk to borrowers and the economy.
APRA has advised lenders across Australia that they will need to limit their interest only loans to just 30% of all new home loans. Many lenders have responded by increasing interest only rates across the board and changing their policies to make interest only borrowing a bit trickier.
Those borrowers who are being hit by the interest rate bumps might be wondering what all the fuss is about. Why are interest only loans being targeted as a risky form of lending?
What’s all the fuss?
When borrowers seek interest only loans for their affordability, particularly owner-occupier borrowers, regulators like APRA get worried. The reason for this is that interest only repayments don’t reduce debt and this can cause issues for borrowers down the track.
First of all, when your debt remains higher for longer you will end up paying the bank more interest and unless this is part of your tax strategy it will suck up a lot of your income with no reward.
Secondly, when you eventually decide to start making principal repayments to your loan you will have a shorter time period to pay it off and this will make your repayments more expensive than they were in the beginning.
Finally if you only make interest only repayments and your property doesn’t grow in value then you won’t be building any equity in your home or coming any closer to home ownership. Further to this, if your property is losing value and you haven’t been reducing your loan amount then this can cause real problems for you in the future.
Should I keep my loan on interest only repayments?
For most investors interest only repayments make sense.
Investors often choose to make affordable interest only repayments on their investment loan so that they can focus more of their income on reducing their owner-occupied loans and building equity in their family home.
From a negative gearing perspective, just paying the interest and not reducing the balance of your investment loan keeps your interest costs high and can maintain strong tax deductions for you on your investment**.
So if you are using a specific tax or debt reduction strategy that includes interest only repayments it would be a wise move to speak to your broker about finding one of the affordable interest only options still available to borrowers.
If you are an owner-occupier who has chosen an interest only repayment to make your loan more affordable however, it may be time to weigh up the cost of principal and interest repayments compared to the now more expensive interest only rates. Your broker should be able to offer you free advice on how to make the switch and how best to manage your loan into the future.