Via the ABC:
When Laura Christopher bought her house in Ipswich, Queensland, she signed up for an interest-only period.
“The fact the repayments were going to be a bit lower was the major drawcard,” she told 7.30.
“But I didn’t quite understand the implications.”
The reason repayments were originally lower is that during an interest-only period, borrowers are not paying off the debt they owe to the lender.
When the term ends — or resets, as it is called in the industry — a borrower will start paying off both principal and interest unless they can secure an additional interest-only period.
And for those who can not negotiate another interest-only loan, it has the potential to increase their repayments by thousands of dollars a year.
Half a trillion dollars of loans to reset
During the most recent property boom, mortgages on interest-only terms became extraordinarily popular in Australia, at their peak accounting for nearly 40 per cent of the market.
The financial regulators realised there was a risk some borrowers signing up to interest-only periods might struggle when they had to start paying back the principal.
According to the Reserve Bank of Australia, the move from an interest-only period to principal and interest repayments costs borrowers, on average, an extra 30 to 40 per cent.
If people are unable to afford the jump, they could be forced into default or into selling a property.
A lot of people doing that at the same time could lead to large falls in the property market.
So, the regulators forced the banks to massively curb how many interest-only terms they were offering.
But the RBA also warned last year that, given the huge number of interest-only loans already agreed to, there were nearly half a trillion dollars of loans resetting over four years and with the new tighter rules on interest-only terms, a lot of those borrowers would not be able to extend the interest-only period.
‘A great deal of stress’
In Ms Christopher’s case, the interest-only period came to an end in 2016 and her bank did not want to extend the term.
Now paying off the principal as well, she saw her repayments jump by nearly $5,000 a year.
“It causes me a great deal of stress and anxiety,” she said.
“I do manage to keep it to myself fairly well but there’s still always that fear that if something big was to happen, I don’t know where I’m going to get the money from to try and keep things going.”
For people who are faced with a steep increase in repayments they can not afford, one option is to attempt to offload the property to pay down the debt.
But Ms Christopher could not get the price she wanted.
“When I tried to sell the house, the way the agent had marketed it was that it was an investor liquidating an asset, which bought out all the tyre-kickers who came in with ridiculous lowball offers,” she said.
Ms Christopher is holding on but she is still struggling with the repayments, even after three interest rate cuts by the Reserve Bank this year.
‘Payments would have gone from$2,000 to $7,000’
Retired police officers Peter and Bronwyn Dwight built up a large property portfolio to fund their retirement.
“After I got interested in property investing, I read so many books on the matter and I decided to create a goal to make a goal for 30 properties,” Mr Dwight told 7.30.
“I think we got up to 16 income-producing properties and that meant we didn’t quite reach our goal.
“But, hey, we set a goal for Mars and we landed on the moon.”
Most of their properties are currently in interest-only periods.
“We went with interest-only mortgages because they provide a cash flow, you’re not paying off the loan, as such,” Mr Dwight said.
They took out a 30-year loan with the Commonwealth Bank on one of their properties.
For the first 15 years, they only paid interest on the loan — with three separate five-year interest-only periods.
When the most recent interest-only period reset this year though, the bank would not give them another interest-only period.
So they faced having to repay the principal in just 15 years.
“If it was going to revert to the principal and interest on the current interest rate that they had, the payments would have gone from about the $2,000 per month up to close to $7,000 a month,” Ms Dwight said.
“Which just wouldn’t have been financially viable for us to maintain, it would have forced us into having to consider selling a property before we were ready to do so.”
After over “14 or 15 applications” to different banks, the Dwights were able to finally secure another interest-only term.
Prepare or struggle
But the Dwights are not out of the woods yet.
They have many other interest-only loans due to convert to principal and interest over the next few years.
“We’ve got five lenders and eight loans,” Mr Dwight said.
“So in the next this year, for instance, there’s two more to go.
“And then over the next three to four years, they’ll begin to come out progressively.”
Ms Dwight warned others not to get caught unaware.
“I would suggest that there are a lot of people who are facing the same difficulties that Peter and I have just been facing and continue to face,” she said.
“If they’re not thinking about it, and they’re not preparing themselves, and they’re not working it through, they’re going to find themselves really struggling.”
Despite their difficulties this year, Mr Dwight remained confident that property was the right option for their nest egg.
“I think the demand for housing is still very, very strong,” he said.
But he is still keeping a close eye on how the interest-only transition plays out.
“With people coming out of interest-only loans all in one hit, I don’t know what will happen,” he said.
“I suppose that we will just ride that through when it happens.”
Don’t ignore the risks
So far, the concerns about the glut of interest-only terms ending at the same time have not caused a surge of loan defaults or investors fire-selling their properties, according to economist Saul Eslake.
Interest rate cuts appear to have helped turn around the market and banks are once again loosening their lending standards with the threat of the royal commission now behind them.
But Mr Eslake warns that people should not ignore the risks.
“It could be that the people for whom the transition is going to be most difficult is the cohort that is yet to make the transition, whereas those who could do it comfortably did it sooner rather than later,” he told 7.30.
“Indeed, some of the Reserve Bank work suggests that a number of people have transitioned ahead of the legal requirement to do so.
“So we’ll have to wait and see how difficult it is for the remainder.”
The first example may or may not be the victim of predatory lending. The second one sure ain’t. Either way, the path to further ponzi-borrowing is now opening up for more specufestors as banks chew through the interest-only reset:
As banks ease lending conditions.