Why regulators are saying ‘NO’ to interest only loans?

In the past, anyone could elect to have an interest only loan – this is not the case anymore. Just because you ask for an interest only loan does not mean you will be granted an interest only loan. The regulators are worried about risky borrowing behaviour and have asked lenders and mortgage brokers to step up to make enquiries into the reason for an interest only loan.

A common strategy for property investors is to ask for an interest only loan, typically for up to 5 years. This gives the investor an opportunity to keep the initial contractual payment low for the first 5 years to allow for a natural increase of rental income and better cash flow to meet outgoing expenses. This makes perfect sense and a great strategy to manage cash flow.

What the regulators are concerned about is, the amount of interest only debt in an individual’s portfolio versus the amount being paid down. The risky behaviour is when an individual has a high percentage of their debt including their personal home loan debt as interest only and no clear exit strategy to actually pay off the loan. It has been common in the past for investors to “rent” the money with a hope and pray strategy that the properties will increase in value. There is no guarantee that all properties will go up in value.

It is very easy to get caught up with the lower interest only repayments, however when the interest only term expires the loan will revert to principal and interest and you then only have 25 years instead of 30 years to pay off the loan. This can hurt if a property investor has several properties on interest only and they start to roll onto principal and interest.

Ideally, paying down the owner-occupied debt (non-tax-deductible debt) first is a good place to start. Market research is critical when acquiring investment property, part of that research requires looking at the numbers, and how the cash flow works on the whole portfolio. Formulating an exit strategy to eventually have the debts either significantly reduced or paid off needs to be a consideration.

There can be good justification in some cases to have the owner-occupied home on interest only scenarios such as renovating a home or building a home. A borrower may want to keep the contractual payment low for a period of 12 months so that maximum cash flow can be funnelled into the renovations. If building, people are often renting so it makes sense to have interest only for the build period.