Why the Brouhaha about interest only loans?

The Media is currently running with the poorly researched idea that Interest only loans are looming as the reason why property is heading into bubble territory and potentially being a massive risk to the economy.

The truth is that interest only loans are the loan of choice for investors. Any accountant will tell you that you should always pay down your non tax deductable debt (o/o home) before you pay down your deductable debt (investment).

It is also being said that buyers applying for these loans are not being scrutinised closely enough and are at risk of default if interest rates rise.  In actual fact all new loans are currently assessed at a rate of between 7.25 % and 8.00% using principal and interest repayments.  When you add an interest only option to this calculation the amount you can borrow actually decreases because the principal repayment of the loan will be calculated using the shorter term.  Eg take a 5 year int only period using a 30 year loan the repayments are calculated over a 25 year term because the first 5 years are interest only.

The Reserve Banks recent remarks about Australia’s high percentage of interest only loans; “This is unusual by international standards,” and “This is one area where Australia stands out” are directly related to Australia’s negative gearing laws which give investors an advantage over owner occupiers in what price they can afford to pay for a property.

  1. The interest component of the debt is tax deductible
  2. The running costs associated with the property are tax deductible

Changes to these negative gearing rules are being talked about for the upcoming budget in May. Treasurer Scott Morrison is understood to be pushing for a change, with support coming from APRA and ASIC in the last week, those ministers that were reluctant to change may be forced to rethink?

Regulators have already had a big impact on banks slowing new lending to investors by:

  • Capping new investment lending growth to 10% per year of book growth.
  • Asking for more detailed investigation into borrowers living expenses.
  • Putting pressure on banks to limit loan to value ratios for new investment lending to < 90%

If we look at the numbers more closely, we find that 60% of investors are taking interest only, largely due to the effects of negative gearing.  Owner occupiers are actually taking up interest only loans at a rate of approximately 20% or 1 in 5 loans.

While the number of investors as a proportion of new loans is historically high, the significant tightening of lending which started in the last quarter of last year should start to flow through the ABS numbers in coming months. The most recent changes, which are to charge interest only loans at a higher rate, should see investors reassess how much they are prepared to pay for property.

For a detailed discussion relating to your circumstances contact Todd McKeon on

0414 678831 or todd@alluna.com.au