Rates for interest-only loans on the rise

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Concern about the growth of mortgage lending across the banking industry has prompted the Australian Prudential Regulation Authority (APRA) to tighten requirements for banks offering interest-only loans. Here, we look at what the changes are, and how they are affecting the lending market.

APRA is concerned that too many mortgage holders are paying interest only on their loans, and therefore not reducing their mortgages over time. In the event on an economic downturn and/or increasing interest rates, this could impact on the strength of the financial system.

As a result, from 1 July 2017, APRA requires that all lenders limit the flow of new interest only loans to a maximum of 30% of all new mortgages.

This has promoted changes in the lending market, the most significant of which is a difference in pricing that has emerged between interest-only and principal-and-interest loans.

Borrowers wishing to take out an interest-only loan can currently expect to pay between 0.3 per cent and 0.5 per cent more than a borrower taking out a principal-and-interest loan. This trend is expected to continue.

Additionally, banks are tightening borrowing rules for interest-only loans. Some have already indicated they are withdrawing entirely from interest-only lending to owner-occupiers, and others could follow.

Positioning for success

While borrowing rules may be changing, lending fundamentals remain the same.

It’s still essential to save a significant deposit and prudently manage your household expenses to ensure you remain in the position to service a loan comfortably.

But as a result of these stringent rules, the lending market has become more complex. There’s also greater variance in the interest rates offered by financial institutions for both interest-only and principal-and-interest loans.

With so many variables in the market at the moment, it’s difficult for borrowers to work out which loan is right for their specific circumstances and needs. 

For some borrowers, interest-only loans may still make sense. But for others, taking out a principal-and-interest loan may be the more appropriate option, especially for owner-occupiers who want the benefits of the lower interest rates currently available, and the reassurance of reducing their home loan over time.

Finding a path through that complexity can be challenging, which is why it makes sense to work with a credit adviser, who can guide borrowers through the different options.

While the Reserve Bank of Australia is expected to leave the cash rate on hold for the moment, other factors are impacting interest rates.

For example, the higher cost of funds, a new bank levy recently announced & the tighter APRA rules explained at the start of this article could all impact interest rates outside of the Reserve Bank making a change.  

The message for borrowers is to ensure they understand the many variables that are factored into interest rates.

The idea is to work with a credit expert, who can ensure you understand your options and help you take out the right loan for your circumstances.

 

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