Lenders providing interest-only mortgages need to lift their standards to adhere to important consumer protection laws, ASIC has warned.

After a regulatory probe into interest-only lending, ASIC identified that demand for interest-only loans had grown by around 80% since 2012. 

In December, the regulator announced it would be conducting a review into interest-only home loans. The review looked at 11 lenders, including the big four banks, how consumers were assessed for loans by lenders with a focus on the affordability of the loans over the longer term.

The review found that interest-only loans are more popular with investors and those on higher incomes, and that delinquency rates are currently lower for interest-only home loans.

However, ASIC also found that lenders have been falling short of their responsible lending obligations in the provision of interest-only loans. According to the regulator, lenders are often failing to consider whether an interest-only loan will meet a consumer's needs, particularly in the medium to long-term.

ASIC’s review of more than 140 consumer loan files from bank and non-bank lenders identified:

  • In 40% of files reviewed, the affordability calculations assumed the borrower had longer to repay the principal on the loan than they actually did
  • In over 30% of files reviewed, there was no evidence that the lender had considered whether the interest-only loan met the borrower's requirements
  • In over 20% of files reviewed, lenders had not considered the borrower’s actual living expenses when approving the loan, but relied instead on expenditure benchmarks

These practices can expose borrowers to not being able to afford their loan repayments in the future, particularly for interest-only loans, which have much higher repayments after the initial interest-only period ends.

“Interest-only loans may be a reasonable option for some borrowers. However, lenders must have robust processes in place for assessing a customer's ability to afford a loan, taking into account the increased repayments once the interest-only period ends. They should lend responsibly, and in a way that does not result in consumers taking on debt that they cannot afford, especially if interest rates rise,” ASIC deputy chair Peter Kell said.

Following ASIC's review, all 11 lenders have changed their practices in line with ASIC's recommendations or have committed to implementing necessary changes in the coming months.