Interest Only

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<div>In August 2017 I attempted to estimate the value and timing of forced interest-only ('IO') resets as a result of tighter lending standards. </div>
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<div>Since that time many rational borrowers have elected to switch to principal and interest (P&amp;I) loans to benefit from the more attractive mortgage rates on offer. </div>
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<div>APRA's quarterly ADI figures showed that the flow of new IO loans was under 16 per cent for a second consecutive quarter. </div>
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<div>This dynamic combination has had a marked impact on the stock value of outstanding IO loans, declining by $93.2 billion of 16.1 per cent year-on-year.</div>
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<div>As a share of ADI residential term loan exposures IO loans have therefore been reduced to 31 per cent as at March 2018, well down from close to 39 per cent a year earlier. </div>
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<div>Most borrowers appear to be handling the switch comfortably.</div>
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<div>Those most impacted are likely to be portfolio investors, although many of this cohort built their portfolios over a long period of time, building equity and cashflow in doing so. </div>
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<div>Some may have to sell a property or two in order to reduce debt. </div>
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<div>The share of higher loan-to-value (LVR) ratio lending continued to tighten in the March quarter, having already declined considerably since 2014. </div>
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<div>The latest figures relate to the first three months of 2018, so it's difficult to know whether the Royal Commission had any further impact over the following period through to June.</div>
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<div>It's interesting to note that the major lenders have lost some market share over time.</div>
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<div>Yet bank share prices saw a punchy rebound this week, possibly relating to a short squeeze, or more likely a pervading sense of relief as the media loses its appetite for daily stories from the Royal Commission. </div>
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<span>PETE WARGENT is the co-founder of AllenWargent property buyers (London, Sydney) and a best-selling author and </span><a href="https://petewargent.blogspot.com/" target="_blank">blogger</a><span>.</span>
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pwargent-M4siyDbqQY

Most IO borrowers handling the switch to P&I comfortably

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<div>EXPERT OBSERVER</div>
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<div>It looks as though tighter deposit requirements have run their course. </div>
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<div>Although December 2018 was a horrible quarter for mortgage lending in the lead-up to the end of the Royal Commission, the squeeze on loan-to-value ratios looks to be just about done. </div>
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<div>There are relatively few interest-only (IO) mortgages being written now, and this squeeze also looks to be about done. </div>
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<div>It's a smaller share of a smaller pie, and this is reducing household debt ratios as we speak (contrary to the incorrect claims you might read elsewhere). </div>
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<div>The ADI stock of outstanding IO loans is now less than ¼ of mortgages by value, the lowest on record across the data series. </div>
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<div>This may sound a lot, but most IO loans revert to principal repayment relatively quickly, and anyway IO mortgages can make a lot of sense for borrowers with offset accounts. </div>
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<div>Many borrowers have opted to revert to principal repayment early for the cheaper mortgage rates on offer. </div>
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<div>There was previously some debate surrounding what constituted a 'new' IO loan, but the interest-only 'cliff' is no longer a thing, since any mechanically forced reset no longer applies. </div>
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<div>It's in nobody's interests to see stressed borrowers go into arrears, so the reset should now be managed comfortably enough.</div>
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<div><strong>Left the building</strong></div>
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<div>It's interesting to note that partly thanks to switching across to cheaper rates, interest repayments have now declined to sit well below 10 per cent of household disposable income, down from 16 per cent a decade earlier.</div>
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<div>This is a very significant decline, and this hugely improved level of mortgage serviceability partly accounts for why mortgage arrears remain so low. </div>
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<div>Betwixt the Council of Financial Regulators and the Reserve Bank today the respective authorities confirmed today that there would be no further tightening of lending standards required, instead perhaps implying that banks rather need to write some business.</div>
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<br><strong>From the RBA:</strong>
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<div><em>"From a financial stability perspective, prudent lending standards are a good thing. They ensure that households and banks are resilient to changes in circumstances. </em></div>
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<em>But there needs to be a balance. </em><em>The regulators are not proposing any further tightening in lending standards. </em>
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<div><em>And the appropriate amount of credit risk is not zero – banks need to continue to lend and that will inevitably involve some credit losses."</em></div>
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<div>Welcome news, while fixed mortgage rates are being cut widely as funding costs have declined. </div>
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<div>The regulators have left the building (for the time being!). </div>
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<em>PETE WARGENT is the co-founder of AllenWargent property buyers (London, Sydney) and a best-selling author and <a href="https://petewargent.blogspot.com/" target="_blank">blogger</a>.</em> </div>
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Interest-only cliff: no longer a thing - Pete Wargent

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<p class="x_MsoBodyText">The announcement of the removal of the 30 percent cap for new interest-only residential mortgages will allow lenders to offer more choice for customers, leading to an increase in competition across the industry, particularly for smaller and regional banks, the Australian Banking Association chief, Anna Bligh said.</p>
<p class="x_MsoBodyText">“While banks will continue to lend prudently, today’s decision will mean all banks can offer more choice for customers who are looking to buy a house or apartment. </p>
<p class="x_MsoNormal"><strong>Average rates according to borrower</strong> </p>
<table class="x_MsoTableGrid" border="1" cellspacing="0" cellpadding="0"><tbody>
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<p class="x_MsoNormal">Owner occupier, principal and interest</p>
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<p class="x_MsoNormal">4.27%</p>
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<p class="x_MsoNormal">Owner occupier, interest-only</p>
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<p class="x_MsoNormal">4.68%</p>
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<p class="x_MsoNormal">Investor, principal and interest</p>
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<p class="x_MsoNormal">4.60%</p>
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<p class="x_MsoNormal">Investor, interest-only</p>
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<p class="x_MsoNormal">4.84%</p>
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<p class="x_MsoNormal">Source: RateCity.com.au</p>
<p class="x_MsoBodyText">“Increased competition across the industry will mean customers have more ability to shop around for the best deal for them when looking at an interest-only home loan,” she said. </p>
<p class="x_MsoBodyText">In terms of banks home loan commitments, the proportion of interest-only loans are now 16 percent much lower than the proportion seen two years ago at 37 percent.</p>
<p class="x_MsoNormal">Sally Tindall, research director at RateCity.com.au, noted APRA’s intervention has had a marked effect on new borrowing.</p>
<p class="x_MsoNormal">“This announcement will see banks re-open their books to more interest-only lenders, particularly investors."</p>
<p class="x_MsoNormal">But Tindall was unsure whether there would be a drop in interest-only rates to attract more borrowers.</p>
<p class="x_MsoNormal">“Banks have grown accustomed to charging borrowers more for interest-only loans," she said.</p>
<p class="x_MsoNormal">The final ACCC report into residential mortgage pricing released last week found that the big four banks collected an extra $1.1 billion over the last financial year as a result of hiking interest-only rates as since March 2017 there has been a 37 basis point average increase in interest rates on investor, interest only loans.</p>
<p class="x_gmail-normal"><span lang="EN">On average the rates are now 32 basis points above investor, principal and interest loans, and 76 basis points above owner occupied, principal and interest rates.</span></p>
<p class="x_gmail-normal"><span lang="EN">“We have also seen an increase in interest rates for owner occupier interest only loans that are up 33 basis points since their lows in March last year,"</span> Mozo’s property expert Steve Jovcevski said.</p>
<p class="x_gmail-normal"><span lang="EN">“</span><span>While we welcome the push to improve lending standards, it’s clear the cap on interest only loans has put the brakes on the investor market.</span></p>
<p class="x_gmail-normal"><span lang="EN">“Coupled with the cooling of the housing markets across the country which have pulled back significantly since their peaks, it’s clear the temporary cap has done its job,” Jovcevski said.</span></p>
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j.ballantyne1990-6AQqhLzZaK

APRA's IO loan cap abolition will allow greater choice for over charged borrowers

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<p>Westpac has denied an AFR report it is giving risky property investors less than a month to find another lender.</p>
<p>The bank is alleged to be sending a single-page letter to investors warning it can "no longer support our commercial relationship with you."</p>
<p data-gtm-vis-first-on-screen-7770372_137="3688" data-gtm-vis-total-visible-time-7770372_137="4000" data-gtm-vis-has-fired-7770372_137="1">Victor Kumar, a director of Right Property Group, a buyers' agency, reportedly has seen the letter sent to property investors.</p>
<p>The letter informs borrowers that Westpac is a responsible lender.</p>
<p>Martin North, principal of Digital Finance Analytics, has reportedly been in contact with borrowers who have received the letter.</p>
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<p>Westpac denied the claims. </p>
<p>Initially Westpac said it was attempting to locate the letter and declined to comment.</p>
<p>"We don't support the claims made regarding the Westpac customer communications," a spokesman later told the AFR.</p>
<p>"Based on the limited information we have been provided, the statements made are incorrect."</p>
<p>As banks are forensically examining their lending books, the Westpac letters are reportedly being sent to interest-only borrowers with multiple properties and high loan-to-value ratios, usually 80 per cent or above.</p>
<p>The investors, who often have up to six properties, have been told they have until October 20 – or less than a month – to find a new lender.</p>
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Westpac denies risky property investors are being given one month to find alternate finance

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<p>Canstar's weekly wrap of interest rates for owner occupiers puts the average standard variable rate at 4.43%.</p>
<p>The rates range from 3.39% to 5.73%.</p>
<p><em><a href="https://www.propertyobserver.com.au/images/2018/5/23/principal.jpg" target="_blank">Click here to open in new window</a></em></p>
<p><img src="https://res.cloudinary.com/dz9xllyip/image/fetch/c_scale,w_580,q_auto:good/https://s3-ap-southeast-2.amazonaws.com/po.images/2018/5/23/principal.jpg" alt=""></p>
<p>Interest only has an average 4.74% rate, with a range from 3.58% to just over 6%.</p>
<p><em><a href="https://www.propertyobserver.com.au/images/2018/5/23/io-loans.jpg" target="_blank">Click here to open in new window</a></em></p>
<p><a href="https://www.propertyobserver.com.au/images/2018/5/23/io-loans.jpg" target="_blank"><img src="https://res.cloudinary.com/dz9xllyip/image/fetch/c_scale,w_580,q_auto:good/https://s3-ap-southeast-2.amazonaws.com/po.images/2018/5/23/io-loans.jpg" alt=""></a></p>
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jonathanchancellor-7SQnKwU6yx

Interest rates for owner occupiers average 4.43% standard variable rate

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<p>GUEST OBSERVATION</p>
<p>Australian taxpayers won’t face a rise in taxes now that Treasurer Scott Morrison announced the government will not increase the Medicare Levy by 0.5% as planned. This was to originally fully fund the National Disability Insurance Scheme (NDIS).</p>
<p>This is on the back of strong company tax receipts stemming from companies using up carry-forward losses accumulated in the wake of the financial crisis.</p>
<p>Australian Bureau of Statistics data for 2016/17, released this week, showed tax revenue for the federal government (including taxes received from other levels of government and public corporations) increased A$19.4 billion (5.2%).</p>
<p>The averted tax rise will be welcome news for Australian taxpayers. It also wedges the Labor opposition.</p>
<p>They have said that the NDIS was fully funded on their watch. So now they are proposing a 0.5% tax rise on all incomes over A$87,000. That’s pretty close to full-time male average weekly earnings and comes close to capturing half of Australian households.</p>
<p>The federal budget on May 8 will no doubt have further goodies for voters in the run-up to the net election, which will be either this year or relatively early next year. As usual, we will be reporting directly from the budget lockup.</p>
<p>One of the central economic puzzles of the last several years has been persistently low inflation in all advanced economies, despite general economic recovery and falling unemployment.</p>
<p>This week’s Australian consumer price inflation figures revealed a 0.4% increase for the March quarter, and 1.9% for the last 12 months. The March quarter figure was below market expectations of 0.5%, and also the previous (December quarter) figure of 0.6%. Education prices were up 2.6% on the quarter, and health prices up 2.2% (or 4.2% for the year to March 2018).</p>
<p>This puts inflation still below the Reserve Bank of Australia’s (RBA) target band of 2-3%. That band, of course, has been in place since the early 1990s – beginning with this speech by then governor Bernie Fraser.</p>
<p>Numerous central banks around the world have a similar approach. The basic idea is that a central bank can build a reputation over time to commit to monetary policy such that inflation lies in the band.</p>
<p>Now there are pros and cons to this approach to monetary policy, and it has its critics. But that is another tale for another day.</p>
<p>Just assuming that inflation targeting is the correct objective, how is the RBA doing? Well, one small hitch in the plan is that inflation has been outside the band for a long time now (basically since 2014), as the RBA’s own figures show.</p>
<p>Given the level of unemployment in Australia, low wages growth, and stubbornly low inflation, the RBA probably should have cut rates further a fair while back. But they seem, probably rightly, terrified of further fuelling a potential housing bubble.</p>
<p>Meanwhile, the credibility of their commitment to the inflation target withers. If only the regulation of our banking and finance sector had been better for the last, say, decade or two.</p>
<p>Speaking of such regulation, RBA assistant governor Chris Kent gave a speech Tuesday about the important issue of interest-only loans. Kent’s speech was significant because it followed up on remarks in the RBA minutes about the same issue that I discussed in this column last week.</p>
<p>It seems that the RBA “house view” on interest only loans is as follows. There could be a problem but the Australian Prudential Regulation Authority (APRA) stepped in and the banks have voluntarily tightened lending standards recently. Also because the <em>average</em> household with an interest only loan has a buffer of savings, everything will be fine. Nothing to see here.</p>
<p>I hope the RBA’s conclusion is right, but I know for sure that the reasoning is not. It’s actually the <em>marginal</em> household’s financial position and behaviour that matters, not the average household.</p>
<p>The average United States borrower with an adjustable-rate mortgage did not default in 2007, 2008 or 2009. But these mortgages were a huge contributor to the financial crisis, along with subprime mortgages.</p>
<p>Kent dutifully laid out the risks from interest only loans, saying:</p>
<p>"Because there’s no need to pay down principal initially, the required payments are lower during the interest-only period. But when that ends, there is a significant step-up in required payments (unless the interest-only loans are rolled over)."</p>
<p>Indeed, unless they can be rolled over. Which they can’t now because of APRA and the banks finally doing something.</p>
<p>Now, prices (interest rates) on interest only loans have gone up as part of the bank response. This has led a bunch of folks to shift to amortising loans, where the principal of the loan is paid down over the life of the loan. So those borrowers who haven’t shifted to these loans already, really don’t want to.</p>
<p>Maybe they can’t afford to because of the increased repayments, that can jump 30% or more per month.</p>
<p>So what does happen? First Kent says many borrowers save ahead of time, expecting a rise in repayments. Yes, the prudent ones.</p>
<p>But how many non-prudent borrowers have there been in the Australian property market in recent years? Hint: a lot.</p>
<p>Kent also points to borrowers who seek to refinance their interest only loan. But banks don’t really want to, and APRA doesn’t want to let them. And who is going to be able to? The safer borrowers who did save and so don’t really need to avoid amortisation. The risky borrowers can’t refinance.</p>
<p>Kent says some borrowers will have to cut their spending. Chuckle, chuckle. And the final option is to sell their house.</p>
<p>Sure, no problem, unless lots of folks want to do that all at once. Then it’s a fire sale that detonates the housing market.</p>
<p>I really do hope we escape the interest only debacle unscathed. But if we do it will be pure, dumb luck, not a consequence of good design or sound regulation.</p>
<p>It definitely doesn’t justify the RBA’s house view in Kent’s concluding remarks that: </p>
<p>"The substantial transition away from interest-only loans over the past year has been relatively smooth overall, and is likely to remain so. Nevertheless, it is something that we will continue to monitor closely."</p>
<p><img src="https://counter.theconversation.com/content/95518/count.gif?distributor=republish-lightbox-basic" alt="The Conversation" width="1" height="1">Perhaps a there should have been a little more monitoring before interest only loans got to be 40% of all loans and more than half of the loan book of one of our biggest banks.</p>
<p><em><strong>Richard Holden</strong>, Professor of Economics and PLuS Alliance Fellow, UNSW</em></p>
<p><em>This article was originally published on <a href="http://theconversation.com" target="_blank">The Conversation</a>. Read the <a href="https://theconversation.com/vital-signs-interest-only-loans-are-an-economic-debacle-that-could-bust-the-property-market-95518" target="_blank">original article</a>.</em></p>
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Interest only loans are an economic debacle that could bust the property market: Richard Holden

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The limits of interest-only lending: RBA's Christopher Kent

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<p>Almost half a trillion dollars in interest-only (IO) mortgages will convert to principal and interest loans over the upcoming four years, according to the Reserve Bank of Australia.</p>
<p>The Reserve Bank estimates around $120 billion in loans will convert to the more traditional principal and interest loans every year between now and 2021.</p>
<p>Despite the large increases in repayments when IO loans reset - officials estimate they will leap by up to 40 per cent - the Reserve Bank believes most borrowers "should be able to afford the step-up in mortgage repayments" because they have accumulated substantial prepayments.</p>
<p>The RBA published figures last Friday showing that around 30 per cent of all outstanding national mortgage debt will be subject to the IO reset.</p>
<p>Some commentators have likened ths forthcoming transition to the wave of adjustable-rate loans that triggered the 2008 US subprime crisis.</p>
<p>While the Reserve Bank has always downplayed the likelihood of any US-style disaster, it admitted the resets are an "area of potential concern".</p>
<p>It is not the first time the RBA has raised the issue as in February the <span>Reserve Bank</span><span> deputy governor Michele Bullock warned n<span>egatively geared property investors with </span><span>interest-only loans</span><span> posed a growing threat to Australias financial system.</span></span></p>
<p>Officials noted in Friday's statements that many households should be able to manage the adjustment given they are ahead with their repayments.</p>
<p>There are around 1.46 million outstanding interest-only mortgages.</p>
<p>The warning came just days after the Reserve Bank governor Philip Lowe warned Australian borrowers that a likely official interest rate hike will come as a shock to some households given they haven't seen one in seven years.</p>
<p>The IO reset risk numbers peaked in 2014, banks encouraged property investors to supercharge their borrowing power by taking out loans in which the principle typically isn't repaid for the first five years.</p>
<p>The loans were then taken up by home buyers too.</p>
<p>Given the interest rate on IO loans has risen, the RBA noted switching was already underway voluntarily.</p>
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<p><span>But some banks also noted an increase in arrears among some borrowers switching to principal &amp; interest (P&amp;I) loans at the expiry of the IO period of their loans. </span></p>
<p><span>"Partly, this was borrowers taking time to adjust to the higher required repayments (given they would then include principal) but most subsequently returned to meeting their payments in full," the bank noted </span></p>
<p><span>However it was only for a small share of borrowers higher arrears.</span></p>
<p><span>"Borrowers voluntarily switching before the IO period expiry – to take advantage of the lower interest rate on P&amp;I loans – were meeting the higher repayments," the RBA noted.</span></p>
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<p>IO loans have been restricted by regulators in two waves of macroprudential restraints - in 2014 and 2017 - amid concerns they were stoking dangerous housing market conditions especially in Sydney and Melbourne.</p>
<p>The issuance of interest-only loans had fallen to around 30 per cent of borrowing by investors.</p>
<p>Last month to was noted brokers are writing significantly fewer interest-only loans as borrower demand plummets.</p>
<p>Mortgage Choice has revealed the proportion of interest-only (IO) mortgages written by its brokers fell by more than 20 per cent in the 12 months leading to February 2018.</p>
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<p>IO loans accounted for 12.22 per cent of all home loans written in February 2018, down by 23.73 per cent to 35.95 per cent.</p>
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<p>The serviceability assessments used to write IO loans incorporate a range of buffers, the RBA noted in the latest Financial Stability Review, published on Friday.</p>
<p>The bank suggested share of borrowers who cannot afford higher P&amp;I repayments - who might not be eligible to alleviate their situation by refinancing - was thought to be small.</p>
<p>"In addition, borrowers who are in this situation as a result of past poor lending practices may be eligible for remediation from lenders."</p>
<p>The RBA noted one important aim was to address the risks posed by the concentration of mortgages on banks’ balance sheets, which have increased in recent years to now account for more than 60 per cent of total loans.</p>
<p>APRA is proposing to raise the minimum amount of capital that must be used to back residential mortgages, relative to other loans.</p>
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<p><span>In addition, APRA proposes to make risk weights on mortgages more sensitive to risk. Risk weights would distinguish between P&amp;I mortgages to owner-occupiers and all other mortgages (which would require more capital), and risk weights for ADIs using the standardised approach would also be more sensitive to the outstanding LVR.</span></p>
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