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A leading Sydney-based mortgage broker has explained how regulatory pressures to reduce interest-only lending are having an adverse impact on the cash flow position of borrowers.
In a recent blog post, Origin Finance broker Graeme Salt weighed up the arguments for and against switching from interest-only (IO) loans to principal and interest (P&I) loans, as banks continue to reprice their mortgages.
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“There was a time when property owners were advised that their investment loans should be interest-only and the loan on their own home should be principal and interest. But now some experts think that borrowers should radically change their loan structure,” Mr Salt said.
“The logic used to be that, as home owners were paying their home loan with after-tax dollars, they should focus on reducing this debt as a priority. Whereas, as the interest on investment loans is tax deductible, borrowers did not need to prioritise paying down these loans,” he said.
“Now, some believe that both owner-occupied and investment loans should be principal and interest (P&I).”
Since the introduction of APRA’s 30 per cent cap on all new IO lending in March, rates on P&I loans have fallen significantly lower than interest-only products.
Mr Salt pointed to recent research that shows the average basic investor variable loan is sitting at 4.87 per cent – some 0.56 per cent higher than the average owner-occupied principal and interest loan. He noted that some standard variable loans are now as high as 5.8 per cent.
“As a result, for some, it may now be more cost-effective turning all loans into P&I to enjoy the benefit of sharper rates,” he said. “And these spreads are likely to get larger. . . . Bankwest announced that it was increasing its interest-only loans by up to 0.35 per cent [recently], while it was reducing some P&I loans by 0.15 per cent.”
One argument for keeping some loans interest-only is that it improves cash flow. However, Mr Salt said that with recent reductions in P&I rates, borrowers may actually be better off paying the principal down, too.
Mr Salt provided this example: If we compare a $400,000, 4.21 per cent P&I investment loan versus a 5.8 per cent interest-only investment loan, the monthly repayments would be: $1,864 (P&I) and $1,933 (IO).
“You can see above that making payments P&I has a better impact on the client’s hip pocket,” he noted.
Several other brokers have been making similar arguments recently, with Aaron Christie-David of Atelier Wealth revealing that he had been advising his clients to use P&I for the past year in recognition that the banks would be tightening up on IO lending.
The interest-only rate hikes by the banks have come under heavy scrutiny by industry figures such as Sydney-based broker Paul Ryan and former bank executive Steve Weston.
[Related: APRA tightening on investor lending ‘short-sighted’]
