27 Mar On an Interest-Only loan? You may not even Know it
A report recently released by investment bank UBS stated that a third of people on interest-only loans are unaware of the details of their own mortgages.
The survey of over 900 Australian mortgagees recently showed a higher than expected proportion of liar loans, but when the bank took a closer look at the data and found that: “our survey suggests that around a third of interest-only borrowers do not know that they have this style of mortgage”.
What does this mean for these borrowers and the market?
This is alarming news for these borrowers and potentially for Australia’s financial stability.
Eventually, the principal must be paid
Interest-only loans are typically taken out for up to five years, after which the borrower needs to start paying off the principal, that is the amount of the total loan.
For some, this jump in repayments is likely to be financially challenging and according to UBS: we believe many borrowers may face substantial stress as interest rates rise or when they revert to principal & interest.
Obviously, this is an even bigger issue if you are unaware that your repayments will rise at the end of that period.
Consider a 30-year home loan of $500,000 with an interest rate of 4 per cent. The monthly payment on an interest-only loan for that property would be $1,666. Switch to a traditional interest and principal loan and the repayment rises to $2,387 a month.
Coming up with an additional $721 per month may not be a problem for some borrowers, but given that household debt levels are the highest they have ever been in Australia it is likely to be a bigger problem in 2017 than it was a decade ago.
A good investment can become a bad one
Yields on residential investments are very low however this has been supported by tax incentives and very low-interest rates. On an interest-only loan, the investment can appear to be great given the low repayments, however this can change once the principal needs to be paid off.
Given that there are some investors taking on multiple interest-only loans to fund other purchases, this problem is multiplied and can become catastrophic if the investors struggle to find a tenant or there is any change to the rental return.
Become financially literate
Financial products can be confusing.
In addition, the lending market is very competitive and for some borrowers, the swiftness of the approval process may mean that they lack the time to fully understand the loan they are taking on.
Understanding that interest rates can change over time is one consideration, however also understanding exactly what you are paying off is important too.
If you don’t know enough about the details of your loan, you should seek professional independent financial advice. It’s important as borrowers need to be prepared for what happens when major lenders increase rates.
If as the UBS research suggests, many of us don’t understand our loans then the risk is that more may default on their loans. Australia’s financial security would then be at stake.
The risk of rising defaults is one of the main reasons why the Reserve Bank of Australia is currently keeping interest rates on hold. Lenders are already increasing rates for interest-only loans. Will this be enough to avoid a financial disaster?
Article written by Nerida Conisbee, 05 oct 2017, https://www.realestate.com.au/news/…