Interest-only mortgage addicts turn to pawn

Via The Advisor:

Interest-only mortgagors are generally wealthier and have a higher risk appetite than other mortgagors, but they are increasingly turning to alternative sources of finance as lending criteria tighten, a Westpac economist has said.

Writing in a bulletin titled Profiling Australia’s ‘interest-only’ borrowers, Westpac senior economist Matthew Hassan and graduate William Chen looked at two data sets relating to owner-occupier loans before the introduction of APRA’s 30 per cent cap on the share of interest-only loans in 2017.

The report argued that, in many cases, the borrowers that are rolling off IO period will be facing increased repayments and may encounter difficulties refinancing against the backdrop of tightening lending criteria.

It noted that interest-only (IO) borrowers have experienced significant increase in mortgage rates between 2014 and 2016, being 46–58 basis points higher than their standard counterparts.

By using data from the Melbourne Institute’s Household, Income and Labour Dynamics in Australia Survey (HILDA), the researchers therefore sought to understand what a typical interest-only borrower looks like to “get a better idea of how some of these pressures might play out”.

The report suggested that just over 12 per cent of mortgagors had IO loan terms, accounting for 3.8 per cent of all households, down slightly on 2014 when just under 4 per cent had an IO loan. The report argues that this “likely reflects tightening lending conditions and the introduction of rate tiering measures from 2015 on”.

…Notably, the bulletin showed that less IO borrowers are ahead of repayments than other types of mortgagors (28.3 per cent compared to 56.4 per cent), which the researchers suggested could be an indication that interest-only borrowers have “less financial ‘headroom’ to make ahead of schedule repayments” and/or reflect that those with higher risk appetites may be more likely to put spare cash towards investment in yielding assets rather than service their mortgages ahead of schedule.

Those behind schedule are also higher than other types of mortgagors — 3.9 per cent versus 2.2 per cent. However, this marked an improvement from 2014 when 7.7 per cent of IO borrowers reported being behind schedule.

“This likely reflects the wider improvement in borrower quality seen in the income, employment and LVR profile of interest-only borrowers. An increased reliance on ‘alternate’ funding sources may also relate to tightening credit criteria and affordability pressures,” the report read.

Further, more IO borrowers are borrowing from others (friends, relatives, solicitors or community organisations) in order to help finance their home purchase, up from 5.4 per cent in 2014 to 7.9 per cent in 2016. This compares to a small decrease among non-interest-only borrowers over the same period.

“It is evident that some are having to resort to alternate sources of finance as lenders apply tighter lending criteria. Some would-be borrowers that have been unable to raise alternate funds have likely been squeezed out of the interest-only market.”

And there will be more.

This is the interest-only refinancing cliff that MacroBusiness has warned about for months.

In a nutshell, Australia’s banks can only issue 30% of new loans as interest-only now. That’s roughly $40 billion per quarter, which would mean that the reset dwarfs the banks’ entire front book interest-only capacity.

Therefore, some large portion will have to transpire in the back book. Our best guess for how much that will be is based upon the history of what the banks have managed previously. We’ve guessed the banks will be able to manage some $25 billion per quarter in the back book as the great reset builds. That means we’ll see the following total resets to principle and interest:

At the peak, that’s 3-4% of the loan book being shocked by 40% repayment hikes. It’s big.

It may also be appearing in the major banks mortgage arrears which have a big jump recently in 90-day buckets (though overall levels remain low):

It also matters because the flow of investor mortgages is a key determinant of house prices growth, especially in the investor hotspots of Sydney and Melbourne, as illustrated clearly by the next charts:

Basically, falling investor demand means falling dwelling prices. And this is before Labor’s negative gearing and capital gains tax reforms are implemented, assuming it wins the next election, which will also smash the investor market.

 

Comments

  1. reusachtigeMEMBER

    I often come across property investors at the parties who are in that industry. Kudos to them, and wow!

  2. There is a big move now to private lending
    SMSF are lending directly and refinancing out banks and taking first mortgage over property = picking and choosing the best deals
    There is a huge private lending market growing
    More the sophisticated investor with a SMSF or who holds just cash
    Over next decade peer to peer lending will grow in size

    • Peer to Peer lending..well, how things have come along!

      I first started hearing about p2p lending in the years preceding 2008. I didn’t hear much about them after 2008, I never wasted much time pondering why.

      p2p lending may work on a small scale for small debts, but without those hooks into government they simply can’t protect themselves against risk and fraud. It isn’t going anywhere.

    • peer to pear lending used to pay off the bank debt is the worst that can happen because it removes money from the system

  3. any one turning to pawn/alternative sources in order to re-finance will be doing it only to buy some time until they sell as interest on such loan will be astronomical.
    expect volumes to start to pick rather rapidly in the coming months. I guess plenty of bargains for Reusa.

  4. I want them to turn to PORN. Pays better.

    PS. I maintain that the maths (and ongoing churn) ensures that there needs to be no reduction in IO in the back book. All current IO loans can be rolled over to IO.

  5. Wino ShinyfaceMEMBER

    So many Euro cars at auctions now, loads of Audi Q5’s the exclusive professional’s car of choice

  6. Come on Pawnocalipse! Daddy needs a very low hours Kubota GR2120 mower for fsck-all dollars 😀

    There was one for $7500 in ButtF*ck Victoria the other month. Wish I had the time then to drive and get it. Oh well, it’s only the beginning.

  7. An I guess if it all falls apart the masses will demand another royal commission along with debt forgiveness. Then it can all start again.

    • Jumping jack flash

      Yeah you can be sure they’ll try for the debt forgiveness, but the reality is the money needs to be repaid plus interest.
      At least from somewhere.

      Maybe crowdfunding is the answer?

  8. FWIW, discussions yesterday with our NAB offshoot ended with an agreement to ‘look at’ rebating overassessed notional interest and ‘redrawing’ the housing loan on an annual basis and re-crediting a current account. (Here, an ‘Offset Loan with this bank is assessed twice (1) when looking at any credit balances and (2) as part of an all-up Scheduled Repayment Amount – when transforming to “P&I” – regardless of any offset.). A variation to ‘extend-and-pretend I guess!

    • Essentially, front book prices are the prices of services available to new customers, and back book prices are all the prices that were previously available to customers, stretching back over time.
      As a rule of thumb, in a competitive market, you would expect front book prices to slowly go down over time.

  9. AMP:

    We are increasing interest rates for new and existing variable rate home loans effective from 13 July 2018 for new business and 16 July 2018 for existing business.
    New and existing business

    Owner occupied principal & interest Increasing by 0.08%
    Owner occupied interest only Increasing by 0.17%
    Investment principal & interest Increasing by 0.17%
    Investment interest only Increasing by 0.17%
    The standard 0.20% rate differential between variable rate term loans and LOCs also remain unchanged and all LOC rates increase accordingly.

    Our decisions on rates are not taken lightly and reflect an increase in funding costs.

    Please note, we are not changing fixed rates. The above interest changes only apply to variable rate loans.

    Our current fixed rates include:
    Professional, Affinity and Select Packages – 3 Year Fixed Rates
    (LVR< 90 % + LMI)
    Package Owner Occupied – Principal and Interest
    Interest rate Comparison rate1
    Professional Package 3.79% pa 4.67% pa
    Affinity Package 3.79% pa 4.41% pa
    Select Package 3.79% pa 4.68% pa

    • Still cheap as chips. And UBank still hasn’t moved a single basis point!

      Cmon UBank, you can do it. Do it for eggy!

    • adelaide_economistMEMBER

      That does seem quite different but part of the explanation lies in the analysis being of all households versus Hartzer talking just about Westpac loans. Maybe Westpac is just particularly irresponsible lol

      • The gossip is they gave out vast amounts of loans to overseas Chinese from their HK branch to invest in RE. So… yeah.

      • Even StevenMEMBER

        Or more likely one is referring to current profile of new customers (50% IO) vs overall loan book (much lower).

  10. Rent money is dead money. IO is renting from the bank. Perpetually refinancing IO is renting forever from a bank.

    If your IO rent to the bank is greater than the market rate of rent, and you’re hanging on in a falling market, you have to ask yourself why? What the hell is it you’re doing? Is that living the dream? Financially, it’s hyper-stupid, but then again this is three property bubbles stacked on top of each other, a hyper-bubble. Hyper-bubble needs hyper-stupid if it has any hope of treading water.

    • It’s too sophisticated for you to understand. Debt is sexy and cool. The word “gearing” makes people moist. The word “offset” makes people hard. Using “other people’s money” makes one a genius. “Renting from the bank” means you’re smarter than the bank. If you need eduction, speak to Reusa or Nathan Birch.

  11. Mega banks ask for massive share buy backs, goes to super, who buy Aus stocks off mega banks, all done. They’ve had it all worked out centuries.