Interest-only borrowers brace for mortgage crunch
Queensland property investor Peter Button "grabbed the profit and ran" when his interest-only loan expired and he realised that refinancing would trigger a hefty increase in repayments.
"I saw a refinancing issue coming over the horizon, it was easier to just get rid of it," said Mr Button who recently sold his two-bedroom apartment in the Brisbane CBD.
But he's one of the lucky ones. Thousands of home owners face a looming financial crunch as $60 billion of interest-only loans written at the height of the property boom reset at higher rates and terms, over the next four years.
Monthly repayments on a typical $1 million mortgage could increase by more than 50 per cent as borrowers start repaying the principal on their loans, stretching budgets and increasing the risk of financial distress.
"The horse has bolted," said Digital Finance Analytics principal Martin North, who blames lax lending standards for the looming squeeze on home buyers.
University of NSW Business School economics professor Richard Holden said the shift "could have a big impact on consumer spending and the economy more broadly", and while the impact on consumers was "not a certainty there are worrying signs".
The latest official data shows tougher lending standards have worked to curb investor lending and helped loans to first-home buyers rise to a five-year high.
But the new rules mean borrowers who need to refinance might not qualify for a new interest-only loan or a principal and interest loan with a lower interest rate or better features.
'Crunch year' looms
DFA, an independent consultancy that advises major banks, has estimated the number of investor and homebuyer interest-only loans and then applied the latest lending criteria to establish whether existing borrowers would qualify.
"This is horribly like the USA scenario with the reset loan rates that catalysed the global financial crisis," said Mr North. "I think 2019-20 will be the crunch years in Australia."
A key factor in the US housing meltdown was when five-year adjustable rate mortgages could not be refinanced and many borrowers were forced into delinquency, or foreclosure.
A big difference is that many of the US problems were caused by low or no documentation loans, widespread fraud by mortgage brokers, lax regulatory oversight and loan securitisations, which enable the original lender to get the debt off its books.
But the scale of local "liar loans" – where borrowers over-stated income or under-estimated expenses – could be as high as one in five, according to analysis
'The question is how big is the risk'
While mortgage defaults reached record levels in Western Australia, the Northern Territory and South Australia in September, there has been little rise in NSW and Victoria due to double-digit house price rises, although prices in those states are now slowing.
"It's certainly a risk to household consumption and economic growth," said Brendan Coates, a fellow at the Grattan Institute.
"The question is how big is the risk. We don't know how many of those forced to switch from interest only to principal and interest loans would simply fund any principal repayments out of other savings, or whether they would reduce household consumption.
"After all many investors minimise their cash flows to maximise the benefits of negative gearing as an investment strategy. And we know that most of those taking on larger debts in Australia appear to be from wealthier households well placed to service those debts, which is very different to the US experience in the lead up to the subprime mortgage crisis."
Some borrowers may be hit
Recent analysis shows that fewer than half of current borrowers have plans on how to repay the principal.
Rising household costs, flat incomes and a slowdown in property prices in Melbourne and Sydney are pressuring strategies that relied upon rising household income and housing prices.
Interest-only borrowers can try to extend the interest-only period, which adds to overall mortgage costs, switch to principal and interest, which increases repayments, or try to renegotiate a better rate with the current lender, or a new lender.
A borrower could switch to a new interest-only loan or find a principal and interest loan with a lower rate or better features.
Small Business Ombudsman Kate Carnell said the looming refinancing crunch could worry eight in 10 small business owners with loans secured against their homes.
Ms Carnell said lenders can help borrowers by providing adequate notice of the term expiry and clear explanation of what it means in monthly repayments based on current interest rates.
"Lenders need to get the communication to borrowers right so they have time to get their finances in order," she said.
Kevin Young, the founder of Queensland's Property Club, one of the nation's biggest investment clubs, warned that more than 20,000 of its investors are struggling to afford mortgage repayments after the bank moved from interest only to principal and interest.
Investor-only loans have peaked
Reserve Bank of Australia analysis shows new interest-only investor loans peaked around 64 per cent in 2014, or more than twice the number of interest-only owner occupied loans.
That's about $111 billion worth of interest-only investor loans, or more than twice the value of investor loans taken out five years earlier, as major lenders battled for market share, DFA analysis shows.
It is also more than three times the value of interest-only loans taken out by homebuyers, the analysis shows.
Mortgage broker numbers show the same borrowing bulge in fixed rate, interest-only loans around 2014 and the slowdown following macro-prudential controls imposed by the Australian Prudential Regulation Authority.
For example, the proportion of interest-only loans arranged by Mortgage Choice, the nation's third largest mortgage brokerage, plunged from more than 44 per cent to just over 12 per cent between 2014 and last year.
Bank exposures declining
Australian mortgages represent about 55 per cent of Australian bank loans, 25 per cent of group revenues and about 30 per cent of cash earnings, according to analysis by investment bank Morgan Stanley.
Major banks are exposed to about $524 billion of investment property loans, which make up about 37 per cent of their Australian mortgage portfolios, according to its analysis. That compares to about 17.5 per cent in the UK and less than 10 per cent in the US.
Westpac Group has the highest exposure, with about 25 per cent of loans held by interest-only paying investors, followed by National Australia Bank, 24 per cent, Commonwealth Bank of Australia, 21 per cent and ANZ, 17 per cent.
Combined interest-only investor and home buyer loans blow out to 46 per cent for Westpac Group's mortgage portfolio, 39 per cent for CBA, 35 per cent NAB and 31 per cent ANZ.