Has Australia gotten too swept up in our great love affair with property?
And they have been consistently rising for close to a decade, since the Australian Prudential Regulation Authority (APRA) started releasing this data in 2008.
According to APRA’s latest quarterly property exposure statistics, released last week, interest-only home loans increased by almost $8 billion in the September 2016 quarter. These types of mortgages now make up 39 per cent of all residential home loans.
But with evidence that house price growth is easing — capital gains recorded over November were the softest they have been since December 2015 — and with mortgage rates on the way back up, the rise in interest-only lending is beginning to ring alarm bells.
“In slow growth markets, which most markets in Australia currently are, if you’re not paying down the principal loan amount and there is a market event that leads to a drop in property prices, a homeowner with an interest-only loan could be left dangerously exposed,” the CEO of HomeStart Finance, John Oliver said.
“Even in current high-growth markets such as Melbourne and Sydney, there is speculation about a potential bursting of the property bubble. If this happens, it could lead to a lot of homeowners losing their properties.
“Australia’s property market is littered with periods when the value of properties actually fell, such as the Sydney market between 2004 — 2007 where prices fell by 8 per cent and Adelaide between 2010 — 2013 where prices fell by 4 per cent.”
CoreLogic figures showed Melbourne house prices dropped by 1.5 per cent in November while Sydney prices rose by just 0.8 per cent. The combined capital city index grew by just 0.2 per cent over the month.
A SLEEPING PROBLEM
Interest-only home loans have typically been popular among property investors because it minimises mortgage repayments in the short-term while investors bank on capital growth in the long-term. So with property investors such a strong force in the Australian property market, Martin North, Principal of Digital Finance Analytics said the increasing popularity of interest-only isn’t surprising.
“We need to understand who are getting those interest-only loans. There is a very strong correlation between interest-only loans and greater investment lending,” Mr North told news.com.au.
“In the last three or four months we have seen investors come back and investor loans are driving the market again.”
But this love affair with property investment, and the subsequent rise in interest-only lending, could now start to cause real headaches at a time when interest rates are starting to rise.
“We have got two issues. The first issue is we have got this continued growth with investor loans and my research tells me investors are still pretty keen on the market … and therefore interest-only loans are being sold,” Mr North said.
“The second issue is we have got interest-only loans with people currently and when they come up for renewal, with interest rates rising, the bank will be asking harder questions about whether they can refinance and repay the capital. And some of those [investors], from my surveys, would indicate they don’t have a plan to repay the capital. That means there is a sleeping problem for those with interest-only loans currently.”
Research from Digital Finance Analytics shows more than eight in ten existing interest-only loan holders expect to refinance their loan to another interest-only loan and more than a quarter had no firm plans as to how they were going to repay if they couldn’t enter another interest-only agreement. Banks, who don’t want borrowers on interest-only terms for long periods, offer fixed-terms on interest-only mortgages, with the average term lasting five years.
This leaves us with a significant amount of investors who have taken advantage of interest-only mortgages, and are “ill-prepared” to switch to principal-and-interest.
They have assumed that price growth will continue at stratospherical levels so they will be able to sell their property and repay the loan, said Mr North, or they have assumed they will be able to continue to roll their loan over on interest-only terms. But house price growth is cooling and banks are tightening interest rates and loan approvals.
“It creates a series of small earthquakes. Those might be tremors that don’t go anywhere but if you think about it in the context of interest rates rising, house price growth slowing going forward, and people who own investment properties who are already underwater in terms of rental yields, and they now find they can’t actually refinance the loan under interest-only terms …
What I’m feeling is people are going to have a nasty shock,” Mr North said.
“If [investors] do run to the exit, they still have got to repay the loan they have got on the property … But if you have a situation where there is a significant downturn, and property prices drop dramatically, then you could be in a situation where some of the interest-only borrowers won’t be able to repay their loans and that could be a significant downward force on the market.”
A WIDER PROBLEM
APRA’s data shows the concern extends beyond property investors. While interest-only home loans are mostly used by investors, owner-occupiers are resorting to this type of structure too, at higher levels than ever.
At the end of the September 2016 quarter, the value of interest-only loans exceeded the value of investment loans by almost $60 billion, compared to just $18 billion a year earlier. At the end of the September 2014 quarter, two years ago, the value of interest-only mortgages was $26 billion less than the value of mortgages to investors. That’s a turnaround of $86 billion in two years.
“At a time when living costs continue to rise there’s no doubt that home buyers, and in particular first-time buyers, see interest-only loans as a quick fix to get into their own home sooner, while also managing everyday costs,” Mr Oliver said.
A sobering thought given a fifth of young borrowers already can’t make their mortgage repayments when rates are at record lows.
So if the market does drop and rates rise, it is not just investors who are headed for trouble.
“If they are not paying any money off the home, no headway is being made on the overall mortgage. By paying off the interest for up to 10 years, no equity will be built up in the home if property prices aren’t rising,” Mr Oliver said.
“If housing prices drop or there is a downturn in the economy then they could be forced to sell the property at a loss, or the banks may repossess the property.”
