Attempts to cool over-heating property market are failing

Attempts to cool the property market are failing as the number of interest-only loans surges back towards last year’s highs, an analysis of new lending figures reveals.

The Reserve Bank of Australia said in its quarterly statement of monetary policy on Friday that despite recent strengthening in Sydney and Melbourne, “overall conditions in the established housing market have eased relative to mid last year”.

The RBA said house price inflation remained below the peaks in 2015 and there had been a drop in the share of interest-only loans which raise concerns for regulators because of the risk that borrowers will not be able to repay once the interest-only period ends.

Latest analysis, however, shows the number of interest-only loans is rising despite banks increasing interest rates on some products and toughening lending terms and conditions.

Loan volumes, which dropped from 40 per cent to 30 per cent of total lending in the nine months to March, have since risen back to 35 per cent following recent rate cuts and better returns from property than other asset classes, such as shares and savings accounts.

Martin North, principal of Digital Finance Analytics (DFA), a consultant to commercial and investment banks, said interest-only loans did fall last year but have since started to raise again.

“Loan to value ratios are indeed down but that does not change the interest-only question, how many have a repayment plan and will need one the next loan review,” he said.

“The RBA is sanguine on the housing market but ignores the highest ever household debt.”

Caught out

Meanwhile there are fears thousands of property investors using the interest-only loans could be caught by rules that might force them to make bigger repayments five years into the term of the loan.

“There is a trap being set for the unwary investors,” warns Mr North.

Some lenders, such as Bankwest, a subsidiary of the Commonwealth Bank of Australia, are telling their mortgage broker network to impose tough new conditions where a borrower wants to switch from a principal-and-interest to interest-only loan, or extend the interest-only period.

Confidential documents show borrowers will be required to provide reasons for the change and “must” be informed of their potential repayment at the end of the interest-only period.

Transfers will be barred where the interest-only period has exceeded 10 years, or the remaining period of the principal and interest payments after the interest-only period is less than five years, documents reveal.

New financial pressures are growing on a “lot of households” because of underemployment resulting in flat or falling incomes and lower disposable income and savings, Shayne Elliott, chief executive of Australia and New Zealand Bank, is warning.

‘Effervescent demand’

Real estate agents in most of the nation’s capitals are expecting another bumper weekend of auctions with clearance rates expected to repeat recent highs of more than 80 per cent.

“Demand is effervescent,” said Christopher Koren, a buyers’ agent for Morrell and Koren, which specialise in high-end properties around Melbourne’s inner suburbs.

“I wish it would slow down so that I could buy some houses,” Mr Koren said. “Strength of demand is palpable. It is coming to the end of the year and a lot of buyers and sellers are hitting the panic button because they are concerned the market will shut down for Christmas and they won’t be able to sell until next March.”

Nick Lower, manager of CBRE city sales, said demand is strong in Melbourne and Sydney from high earning private investors buying commercial property, typically their work premises.

Reserve Bank of Australia, APRA and ASIC are attempting to cool property speculation by pressuring lenders to clamp down on interest-only loans on which interest is paid during a set period and no principal is automatically amortised.

They fear lower repayments rates are encouraging property buyers and speculators to borrow too much without regard for how they will eventually repay the principal, inflating prices and potentially creating repayment problems if interest rates rise.

Repayment ignorance

A new survey by DFA reveals four-in-10 interest-only borrowers have no idea when, or how, they will start to repay the principal and that 90 per cent are hoping to roll indefinitely their interest-only term.

“Some borrowers on an interest-only loan may get a rude shock when next they try to roll their interest-only loan if they do not have a clear repayment plan,” Mr North said.

Australian Prudential Regulation Authority has set strict new guidelines for lenders to make it tougher for borrowers to roll over their interest-only loans without repaying the principal.

“APRA expects interest-only periods offered on residential mortgage loans to be of limited duration,” it warns in a recent letter to lenders.

It insists lenders have a “prudent serviceable assessment”, which has been interpreted by lenders to mean tough reviews every five years of an interest-only borrowers ability to repay the outstanding debt. That could mean unsuitable borrowers could be forced into more expensive principal and interest repayments.