Can you really afford Interest Only?

By

Expert Advice with Todd Hunter. 5/06/2017

If you have read a newspaper lately, you no doubt have come across the APRA changes that are taking effect in the lending world. If you think they have finished with the financial industry, think again. My thoughts are that home loan applications are going to go back to the 1980’s, where it was so hard to get a loan. You almost need to get dressed up in your best suit to meet the bank manager, to help make your case as to why the bank should lend you money.

One of the most recent red flags that has arisen is the rise in interest only loans… Who would have thought, hey? Sydney and Melbourne prices have exploded beyond belief and now 3 years later, the lenders are questioning the decisions made by borrowers. I’ll be happy to stand up and say that I believe a lot of those “home buyers” out there actually have Interest Only loans… yes, that means those buyers have paid those huge prices and budgeted to only pay the interest, not actually repay their loan?

Oddly enough, your borrowing capacity is reduced if you decide to take up an Interest Only loan, even though the repayments are considerably less. The reason for this is because the lenders must take into consideration the loan repayment when the loan reverts back to principle and interest. And given you have now paid 5 years as Interest Only, that means that there are 25 years left of your loan term, to repay the full amount, as opposed to 30 years. Now sure, you could refinance at the end of the 5 years Interest Only period, but the lender must be responsible and assume that you may not be able to.

So if you only have investment debt and no home loan debt, then making Principle and Interest repayments may be a much more suitable solution.

I am not sure how but Interest Only home loans have become fashionable. Now let’s look at the dumb logic behind this. Tell if I am wrong, but the reason you purchased a home was to stop paying rent i.e. someone else’s mortgage. Now this makes some sense, but given the majority of your Principle and Interest loan repayment is interest, isn’t paying interest to the bank the same as paying rent? Neither benefit you!

So wouldn’t you then want to reduce the principle as fast as possible? How does paying Interest Only or essentially renting your own home make any sense?

The scary part is that the latest figures state that up to 40% of all homeowners are only paying Interest Only. Essentially they are 100% banking on their property increasing in value.

And looking into the future, if interest rates increase in a few years and these homeowners start to come to the end of their Interest Only periods, how are they going to afford the significant jump in loan repayments? Or will they start to default? The latest stats show many households have less than an extra months mortgage repayment as available cash each. Not much wiggle room!

The numbers are scary, so be smart and not a statistic. If you can’t afford your loan repayments at 9%, consider whether holding the property is really worth it. For those who don’t believe interest rates could ever get back up there again, well it was only 8 years ago when they were, so good luck!

....................................................................


Todd Hunter is director, buyer’s agent and location researcher for Sydney-based wHeregroup. He is an active property investor himself and amassed a portfolio of 50 properties by the age of 31. For more of Todd's musings, see his Expert Advice section on our website OR visit the wHeregroup blog.


Disclaimer: while due care is taken, the viewpoints expressed by contributors do not necessarily reflect the opinions of Your Investment Property.

 

With interest rates at their lowest for more than 50 years, there are some great rates available. The best thing to do is to compare rates from all the lenders. Let us help take the leg work out of doing this - Compare Home Loans now

Top Suburbs : menai , rockville , artarmon , geelong west , wiley park

go back