Property owners with interest-only mortgages have been urged to get their finances in order or risk being forced to sell, following a warning from the Reserve Bank of Australia.
On Friday, the central bank warned that over the next four years around $500 billion worth of interest-only mortgages would reach the end of their five-year interest-only period.
That $500 billion represents around one-third of the nation’s entire mortgage stock – that is, the total amount owed by home owners and property investors to mortgage lenders (mostly banks).
Thanks to much tighter lending standards, a large chunk of these interest-only mortgages would then be reset to principal and interest loans, an event which would see repayments rocket by 30 to 40 per cent.
While the RBA did not predict this would have a serious effect on the financial system or the wider economy, other commentators have warned it could see a large number of Australians forced to sell their properties and, consequently, yet more downward pressure on house prices.
Martin North, principal of Digital Finance Analytics, told The New Daily a large number of affected borrowers – as many as half, in his experience – were not even aware they had interest-only loans, and as such were risking being caught by the reset and forced to sell in a falling market.
What is the problem?
Over the past decade there has been a huge rise in interest-only loans. The vast majority of these have been on investment properties, as record low interest rates, combined with rocketing property prices, have encouraged investors to pile in. Negative gearing and capital gains tax concessions have further encouraged this.
However, more than 20 per cent of interest-only loans belong to owner occupiers, meaning this is not just a problem affecting investors.
Most interest-only loans have a five-year interest-only period, after which they reset to more conventional ‘principal and interest’ loans.
The current boom in interest-only borrowing took off around five years ago, and lasted until last year, meaning a large cohort of borrowers will begin reaching their five-year reset point over the next four years.
These borrowers will have three options.
First of all, they can roll over their loan into another interest-only loan. However, to do this they will need to meet much more stringent credit assessments.
The second option is to convert the interest-only loan into a principal and interest loan, and accept the 30 to 40 per cent rise in repayments.
The third option, for those who are unable or unwilling to follow either of the first two options, is to sell their property.
The RBA expects most people to fall into the first two groups, but others are more bearish.
How to protect yourself
Mr North told The New Daily the issue would be a “big deal”.
“I think there will be some households who are forced to sell. The same thing happened in the UK, and it was enough to put downward pressure on the market,” he said.
He said such downward pressure would likely affect certain locations and certain types of property. He said new apartments were particularly vulnerable.
As a result of this and a number of other factors, Mr North predicted property prices would fall by 15 to 20 per cent over the next couple of years.
So what can you do to protect yourself from being forced to sell? Mr North said the first step was to find out whether or not your mortgage is interest-only. A surprising number of people – half – have no idea they are servicing interest-only loans, he said.
The second step is to find out when the five-year period is up.
“The next step is to find out what you can do. Can the loan be rolled over? Of will you be forced to revert to principle and interest?” he said.
If neither of those prove to be an option, he said home owners would need to prepare an “exit strategy” – that is, prepare to sell.