Authorities cracking down on interest-only loans

Authorities cracking down on interest-only loans

Australia’s financial services regulator will investigate lenders and mortgage brokers who write relatively high volumes of interest-only loans.

ASIC said this would form part of the second stage of its review into whether lenders and brokers are inappropriately recommending interest-only loans.

The regulator will probe specific lenders and brokers, who have been chosen, in part, because of their “relative share” of interest-only home lending.

“ASIC will examine individual loan files to ensure that lenders are providing interest-only home loans in appropriate circumstances,” according to the regulator.

“ASIC will carefully review cases where owner-occupiers have been provided with more expensive interest-only home loans, to ensure that consumers are not paying for more expensive products that are unsuitable.”

Big four banks cut back on interest-only lending

ASIC also announced the results of the first stage of the review, which involved collecting data from the big four banks, as well as 12 smaller banks and non-bank lenders:

ASIC found that the big four have reduced their interest-only lending from $19 billion in the September 2015 quarter to $14.3 billion in the June 2017 quarter – a drop of 24.7 per cent.

“However, other lenders have partially offset this decline by increasing their share of interest-only lending,” the regulator added.

The review also found that borrowers who used brokers were more likely to get interest-only loans than those who went directly to a lender.

Another finding was that borrowers approaching retirement age “continue to be provided with a significant number of interest-only owner-occupier loans”.

‘No excuses’ for doing the wrong thing

ASIC deputy chair Peter Kell said that any party that offers interest-only loans must make thorough inquiries into the financial status and needs of their clients.

“The spotlight has been firmly on interest-only lending for some time, and there are no excuses for lenders and brokers not meeting their legal obligations,” he said.

“While interest-only loans may be a reasonable option for some borrowers, lenders must make appropriate enquiries into the needs and financial circumstances of their customers, and they must be able to demonstrate that they have done so.”

In March 2017, APRA, the banking regulator, told lenders that no more than 30 per cent of their new loans should be interest-only loans.

This was part of a broader edict, which was designed to “reinforce sound residential mortgage lending practices in an environment of heightened risks”.

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Learn more about home loans

What do mortgage brokers do?

Mortgage brokers are finance professionals who help borrowers organise home loans with lenders. As such, they act as middlemen between borrowers and lenders.

While bank staff recommend home loan products only from their own employer, brokers are independent, so they can recommend products from a range of institutions.

Brokers need to be accredited with a particular lender to be able to work with that lender. A typical broker will be accredited with anywhere from 10 to 30 lenders – the big four banks, as well as a range of smaller banks, credit unions and non-bank lenders.

As a general rule, brokers don’t charge consumers for their services; instead, they receive commissions from lenders whenever they place a borrower with that institution.

What is an interest-only loan? How do I work out interest-only loan repayments?

An ‘interest-only’ loan is a loan where the borrower is only required to pay back the interest on the loan. Typically, banks will only let lenders do this for a fixed period of time – often five years – however some lenders will be happy to extend this.

Interest-only loans are popular with investors who aren’t keen on putting a lot of capital into their investment property. It is also a handy feature for people who need to reduce their mortgage repayments for a short period of time while they are travelling overseas, or taking time off to look after a new family member, for example.

While moving on to interest-only will make your monthly repayments cheaper, ultimately, you will end up paying your bank thousands of dollars extra in interest to make up for the time where you weren’t paying off the principal.

What is 'principal and interest'?

‘Principal and interest’ loans are the most common type of home loans on the market. The principal part of the loan is the initial sum lent to the customer and the interest is the money paid on top of this, at the agreed interest rate, until the end of the loan.

By reducing the principal amount, the total of interest charged will also become smaller until eventually the debt is paid off in full.

Mortgage Calculator, Repayment Type

Will you pay off the amount you borrowed + interest or just the interest for a period?

Interest Rate

Your current home loan interest rate. To accurately calculate how much you could save, an accurate interest figure is required. If you are not certain, check your bank statement or log into your mortgage account.

How can I calculate interest on my home loan?

You can calculate the total interest you will pay over the life of your loan by using a mortgage calculator. The calculator will estimate your repayments based on the amount you want to borrow, the interest rate, the length of your loan, whether you are an owner-occupier or an investor and whether you plan to pay ‘principal and interest’ or ‘interest-only’.

If you are buying a new home, the calculator will also help you work out how much you’ll need to pay in stamp duty and other related costs.

What is the best interest rate for a mortgage?

The fastest way to find out what the lowest interest rates on the market are is to use a comparison website.

While a low interest rate is highly preferable, it is not the only factor that will determine whether a particular loan is right for you.

Loans with low interest rates can often include hidden catches, such as high fees or a period of low rates which jumps up after the introductory period has ended.

To work out the best value for money, have a look at a loan’s comparison rate and read the fine print to get across all the fees and charges that you could be theoretically charged over the life of the loan.

Does Australia have no cost refinancing?

No Cost Refinancing is an option available in the US where the lender or broker covers your switching costs, such as appraisal fees and settlement costs. Unfortunately, no cost refinancing isn’t available in Australia.

Can I change jobs while I am applying for a home loan?

Whether you’re a new borrower or you’re refinancing your home loan, many lenders require you to be in a permanent job with the same employer for at least 6 months before applying for a home loan. Different lenders have different requirements. 

If your work situation changes for any reason while you’re applying for a mortgage, this could reduce your chances of successfully completing the process. Contacting the lender as soon as you know your employment situation is changing may allow you to work something out. 

Can I get a home loan if I am on an employment contract?

Some lenders will allow you to apply for a mortgage if you are a contractor or freelancer. However, many lenders prefer you to be in a permanent, ongoing role, because a more stable income means you’re more likely to keep up with your repayments.

If you’re a contractor, freelancer, or are otherwise self-employed, it may still be possible to apply for a low-doc home loan, as these mortgages require less specific proof of income.

Will I have to pay lenders' mortgage insurance twice if I refinance?

If your deposit was less than 20 per cent of your property’s value when you took out your original loan, you may have paid lenders’ mortgage insurance (LMI) to cover the lender against the risk that you may default on your repayments. 

If you refinance to a new home loan, but still don’t have enough deposit and/or equity to provide 20 per cent security, you’ll need to pay for the lender’s LMI a second time. This could potentially add thousands or tens of thousands of dollars in upfront costs to your mortgage, so it’s important to consider whether the financial benefits of refinancing may be worth these costs.

Is there a limit to how many times I can refinance?

There is no set limit to how many times you are allowed to refinance. Some surveyed RateCity users have refinanced up to three times.

However, if you refinance several times in short succession, it could affect your credit score. Lenders assess your credit score when you apply for new loans, so if you end up with bad credit, you may not be able to refinance if and when you really need to.

Before refinancing multiple times, consider getting a copy of your credit report and ensure your credit history is in good shape for future refinances.

I have a poor credit rating. Am I still able to get a mortgage?

Some lenders still allow you to apply for a home loan if you have impaired credit. However, you may pay a slightly higher interest rate and/or higher fees. This is to help offset the higher risk that you may default on your repayments.

I can't pick a loan. Should I apply to multiple lenders?

Applying for home loans with multiple lenders at once can affect your credit history, as multiple loan applications in short succession can make you look like a risky borrower. Comparing home loans from different lenders, assessing their features and benefits, and making one application to a preferred lender may help to improve your chances of success