Is The Interest Only Loan Approval Cap to be Removed?

Interest Only Loan Approval Cap Being Removed - Vie Financial

Residential properties in Tasmania looked at by potential investors.The Australian Prudential Regulation Authority’s (APRA) mid-December decision to remove the cap on interest-only (IO) residential mortgages has raised questions regarding what this move will mean for people seeking investment property and personal home finance.

Why Did APRA Place a Cap on Interest Only Loans?

You do not need to go back very far to see the circumstances that led up to APRA’s decision to place a 30 per cent cap on interest only loans for residential property. The limit on the ratio of interest-only loans to other types of residential finance came a few years after APRA’s 2014 decision to place a 10 per cent growth limit on investor lending.

At the time APRA’s regulation sought to taper the large pool of new construction loans and deluge of new investor lending. The cap on interest-only lending put into place by APRA in March 2017, came to pass because more than 40 per cent of residential loans were interest-only.

APRA officials believed homeowners with an IO mortgage had a greater chance of default. Additionally, there were concerns that high numbers of consumers with interest-only loans were in over their heads. Other factors that led to APRA’s decision included:

  • High, and rising household debt
  • High housing prices
  • Slow wage growth
  • Historically low interest rates
  • The large number of loans being made to consumers with high debt to income levels and high loan to value ratios

What Occurred as a Result of the APRA Imposed Cap on Interest Only Loans?

APRA’s 30 per cent cap was instrumental in assisting rein in interest only residential lending. Along with the sought after effect, the cap brought claims from the Productivity Commission and others that it limited competition within the finance industry because the four major banks could work as a unit under the confines of APRA’s regulations. Some of the changes that occurred as a result of the caps introduction were:

  • A measurable decrease in the number of interest only loans during the period the cap was in place
  • Improved lending standards with an emphasis on debt to income ratios for potential home buyers
  • Decrease in limits of loan amounts
  • A decline in home prices, especially in major cities
  • A rise in interest rates for customers with interest only loans
  • Closer attention to loan value ratios on interest only loans

If the Cap on Interest Only Loans Had the Intended Effect, Why has it Ended?

One of Vie Financials offices in Tasmania.The recent move seems like backtracking to some, who feel the regulations were active for a very short period of time. However, APRA Chairman, Wayne Byres, went on record as saying the 30 per cent benchmark was never intended to be a permanent change. Instead, the cap was introduced to serve as a speedbump to slow the increase in IO lending.

The popularity of interest only loans rose as the price of homes increased. The number of IO loans topped 40 per cent when the limiting regulation went into effect.

APRA are satisfied with the changes the 30 per cent cap brought to the industry. The Chairman feels the cap fulfilled its intended “purpose of moderating higher-risk lending and supporting a gradual strengthening of lending standards across the industry over a number of years.”

The cap helped APRA prove its ability to exercise control in the industry. The limits imposed just ahead of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry report looked like a gesture of good faith to some. However, others who took significant financial losses because of numerous failings in the system were unimpressed, viewing the new regulations as too little too late.

In the most recent Financial Stability Report released in October 2018, the Reserve Bank of Australia (RBA) gave a nod of approval to the changes APRA’s 30 per cent benchmark brought to the industry. In the report, the RBA notes the following positive changes since the implementation of the IO cap.

APRA also points to information compiled in the Authorised Deposit-taking Institution (ADI) Property Exposures publication. As seen in the data below, for the September quarter, ADI data showed an overall gain in several strategic statistics.

The following key statistics do not include ADIs that are not banks, building societies or credit unions.

  • TOTAL COMMERCIAL PROPERTY EXPOSURE LIMITS were up 4.5% from $317.4 Billion in September 2017 to $331.8 billion in September 2018
  • TOTAL COMMERCIAL PROPERTY EXPOSURES saw an increase of 4.6% from $267.3 billion during September 2017 to $279.6 billion in September 2018
  • COMMERCIAL PROPERTY EXPOSURES WITHIN AUSTRALIA rose 5.0% from$229.9 billion in September 2017 to $241.3 billion for the September quarter 2018
  • TOTAL DOMESTIC HOUSING LOANS increased 5.4% from $1,533.8 billion in September 2017 to $1,636.9 billion for September 2018

Gains also occurred for ADIs with housing loans in excess of $1 billion.

  • NUMBER OF HOUSING LOANS rose 2.0% from 5,801,000 during September 2017 to 5,918,300 in September 2018
  • AVERAGE BALANCE OF HOUSING LOANS increased 3.5% from $264,500 in September 2017 to $273,700 for the September 2018 quarter
  • NEW HOUSING LOANS APPROVED IN THE QUARTER saw the only decline slipping 7.4% from $96.4 billion in September 2017 down to $89.2 billion during September 2018

The full APRA publication is available for viewing on the APRA website or in the link above.

Now That The APRA Benchmarks Are a Thing of The Past, What do Experts See Happening?

The effects of APRA’s removal of both the 2014 and the 2017 limits are on the minds of nearly everyone in the industry. Maintaining a calm atmosphere, is a wise tactic in this situation. Any type of knee jerk reaction holds the potential to destabilise gains made while the benchmarks were in place.

Experts generally see different effects of APRA’s cap removal. The impact of the move will create two separate responses, one from the residential homeowner side and the other from the property investor side.

Home Owners

  • Those applying for loans to purchase a property as their primary residence are likely to discover that APRA still has a few regulations on the table. Preventing significant financial difficulties and conditions that push homeowners to default on their IO loans was a goal of APRA’s 30 per cent limit on interest only loans, especially for borrowers who do not show reasonable means to service the loans.
  • Homeowners who already have an IO loan can expect to see the loan revert to principal and interest. Many of the recent IO loans are close to reaching their five-year limit. Many lenders indicate they are not likely to extend the terms of these interest only loans. The situation will stretch many homeowners who struggle under the weight of interest only payments who will likely be pushed to their limits with P&I repayments. Although, some of these homeowners may find the financing they are looking for from a private lending source.
  • Odds of approval for a new interest only loan are low for those looking to occupy the property they wish to buy. Banks are exercising more scrutiny when looking at living expenses and are backing away from potential borrowers with poor repayment history or black marks on their credit file.

Investors

  • The outlook for property investors is a bit brighter than for homeowners in the wake of the lifted regulations. Industry experts predict that the rates of interest only loans will decrease to levels on par with current principal and interest loans.
  • Choosing appropriate lenders is extremely important in the current financial climate.

With the right funding source, the changes APRA’s move has brought forward can be navigated.

Jesse Medwin, Vie Financial

Introducing Jesse Medwin of Vie Financial Launceston

Franchise Principle of the recently opened Launceston office, Jesse brings with him over 8-years of experience in the financial services sector, a wealth of industry knowledge, and a proven track record for establishing and maintaining long-term customer and referral relationships.