More Aussies are using interest-only loans for their own homes
Almost a quarter of owner-occupier loans are now interest-only. How risky is that strategy?
Interest-only loans are often thought of as an investment tactic. Investors take out an interest-only loan out to buy a property, rely on rent to cover the majority of the repayments, and claim any additional funds needed to pay off the loan against their taxable income.
However, in its most recent biannual review of financial stability, the Reserve Bank of Australia highlights the fact that there have been an increasing proportion of owner-occupiers taking out interest-only loans.
You can see that on the following chart. The proportion of interest-only loans to owner-occupiers was below 15% in 2009, but has recently crawled above 25%. (ADIs stands for authorised deposit-taking institutions, which is a fancy way of saying "banks and other lenders".)
Owner-occupiers taking out an interest-only loan are effectively betting that the increased value of their property over time will allow them to eventually pay off the principal. However, if the housing market stagnates or property values fall, that strategy may not pay off.
So why take that risk? The Reserve Bank review explains: "Anecdotal information suggests that some owner-occupier borrowers may be using interest-only loans as a means of affording a larger loan." In other words, if your repayments are purely interest, you can borrow more money and afford a fancier house.
This is not a strategy for the faint-hearted, and it also helps if you're earning a healthy pay packet in the first place. A review of interest-only loans by the Australian Securities and Investment Commission (ASIC) found that the riskiness of these loans was offset by the fact that they're typically only offered to higher-income borrowers, generally have a loan-to-value ratio (LVR) below 80%, and are often paid off quickly. "The challenge for lenders will be to ensure that the risk profile of these loans does not deteriorate," the Reserve Bank noted.
Balancing the needs of investors and buyers has become increasingly tricky. Financial institutions have been told by regulators to reduce the proportion of loans made to investors this year, to reduce the levels of overall risk to the economy.
The Reserve Bank holds its monthly meeting tomorrow (3 November). It's expected to maintain official cash rates at 2.0%, with 80% of economists in finder.com.au's regular survey predicting that the rate will hold.
Picture: Mark Moz, licensed under Creative Commons Attribution-NonCommercial-ShareAlike 2.0 Generic
