Australian lenders are said to be falling short of responsibilities when they assess interest-only home loan eligibility. This, according to the Australian Securities and Investments Commission (ASIC), is due to relaxed lending standards, which need to be changed in order for lenders to meet their legal requirements.
According to a recent ASIC review into interest-only home loans, lenders have been urged to lift their standards otherwise they may fail to meet consumer protection laws. In the review, ASIC evaluated over 100 consumer loan files from more than 10 lenders, including the National Australia Bank, Westpac, the Australian New Zealand Banking Group and the Commonwealth Bank.
Of the 140 loan files reviewed:
40 percent of cases assumed that the borrower had longer to repay the principal on their loan than they actually did.
In 30 percent of the cases, there was no evidence gathered to suggest that an interest-only loan was the best type of loan for the borrower.
In just over 20 percent of the cases, lenders had not reviewed the borrower’s actual living expenses. Instead, the lender had relied on expenditure benchmarks to calculate these costs.
Has the Demand for Interest-Only Loans Grown?
The interest-only home loan business is said to be growing at a rate of 20 percent per annum, or approximately eight times faster than Gross Domestic Product (GDP) growth. Economist say that these figures indicate that there may be problems in the future, but it will be sometime before any issues are likely to arise.
According to ASIC, since 2012, the demand for interest-only loans has grown by approximately 80 percent. Interest-only loans are popular amongst investors as this form of home loan allows them to minimise their initial holding costs so that they can build-up capital. But, the down side is an interest-only loan often results in the borrower paying significantly more in interest over the course of the loan. For example, a $350,000 home loan held over 25-years, which has an interest-only period of 5 years with an interest rate of 5.5 percent will incur $29,000 more in interest than a principal and interest loan over the same term.
Let’s look at some other examples. The following table is based on a $500,000 home loan at a consist interest rate of 6 percent over a 25 year term.
|Length of Interest-Only Period||Interest Payable Over Loan Term||Additional Interest Paid Compared to Principal and Interest Home Loan|
So while an interest-only loan can represent a good option for some borrowers, it is important that a lender has assessed the borrower’s ability to afford the loan. It is also imperative that a lender takes increased repayments into consideration so that when the interest-only period ends and the interest rate rises, borrowers can afford to make their home loan repayments without any additional financial pressure.
There is also added concern over owner-occupiers electing to take out interest-only loans to reduce their home loan repayments. While this option can make buying a home more affordable, it also means that home buyers are not reducing their home loan principal and building equity in their home to increase their assets and to reduce their debt. This then means when interest rates rise that these home buyers may struggle to afford their home loan repayments.
What Have Lenders Done to Adhere to ASIC Recommendations?
Lenders have taken a number of actions to increase their responsibilities so that they meet their legal requirements when assessing home loan suitability. The changes lenders have made include:
Agreeing to ensure that loans align with consumer objectives and requirements.
Rather than using benchmarks to estimate home loan affordability, they are now using actual borrower expenses to calculate home loan affordability.
Allowing financial buffers to be added to home loan affordability assessments, so that future interest rate rises are accounted for, which ensures that borrowers can afford to repay their home loan even when rates increase.
What are the Advantages and Disadvantages of Interest-Only Home Loans?
There a number of advantages and disadvantages associated with interest-only home loans, depending on individual circumstances and investment goals. However, the most common are as follows:
The advantages of interest-only loans
o You can reduce your exposure to rises in property investment outgoings.
o You can improve your negative gearing in relation to tax.
The disadvantages of interest-only loans
o Rental yields, at present, are typically 3 to 4 percent and home loan interest rates are around 4 percent, so you are relying heavily on capital growth to make interest-only investment viable.
o Plus, you’ll have to pay more to service an interest-only loan once your interest-only terms ends, which is typically 5 years.
Do you want to know more about interest-only home loans? Then contact eChoice. We can help you find the right home loan for YOU.
Written by eChoice
Since 1998, eChoice has helped more than 50,000 Australians secure a home loan through its network of over 25 lenders and hundreds of loans. Best of all our service is cost and obligation free!