There has been a great deal of media coverage about the alarming number of interest-only loans in the market place as well as the fear that many mortgage holders may face difficulty making repayments if these loans were to switch to principal and interest. This week we explore your options when it comes to the expiry of your interest-only period on your home or investment property loan.

Interest-only loans have typically been utilised by property investors given the tax strategies involved, however over recent years more have been taken out by homeowners. ASIC estimates that this is in fact 1 in 4 interest-only loans that are taken out by homeowners, which for many will not be a sensible option. The key appeal for interest-only loans for many is that the repayments are lower, because you’re not repaying any principal off the loan during the interest-only period.

Why is there so much concern about interest-only loans ending?

Estimates suggest that there are approximately $500 billion in outstanding interest-only loans across Australia. The Reserve Bank of Australia (RBA) expects that many of these will be reaching the completion of their interest-only period over the next 2 years, and expects this to lead to a significant jump in mortgage repayments. A key issue with interest-only loans, is that when your loan does revert to principal and interest, you are in effect paying off the principal component over a shorter period if you don’t refinance, which can result in a significant increase in your mortgage repayments.

You can explore what a significant impact a change from interest-only to principal and interest can have on your loan with our online repayment calculator here.

How are Australian expats likely to be impacted?

Given the tighter credit conditions felt in the marketplace, it can be very difficult to refinance a loan at the end of the interest-only period, which means that the only choice may be to have the loan revert to principal and interest repayments. This is particularly the case for Australian expats given how tight the credit market is currently for overseas borrowers. You can find out more about how Australian expats in particular have been impacted by the latest credit policy changes in our recent article here.

What are your options when you’re reaching the interest-only expiry date?

1. Extend your current interest-only loan with your lender

You can request that your current lender allow you to extend your interest-only period on your loan. This may require a new application and assessment by the credit team under the current policy, so there is no guarantee that they will grant it, however lenders will also aim to retain their customers. The recent crackdown by APRA an tightening of credit policy by lenders across Australia will likely make this option difficult, however if your lender is willing to grant it, then it will require the least amount of effort on your part.

Case Study: Norman currently owns 5 investment properties across Australia, and all of his loans are structured on an interest-only basis. He knew that they were coming up to their expiry date, so well before this he assessed whether he would be able to extend these with his current lender. He found that to do so he would need to decrease some of his other fixed monthly expenses, which would allow him to extend the interest-only period as he could then comfortably service the loans. By reviewing his options early, Norman allowed himself sufficient time to adjust his budget to suit his property goals.

2. Revert your current loan to principal & interest with your current lender

For many borrowers, this is one of the few options available, which can particularly be the case for Australian expats if they no longer pass the serviceability tests of other lenders to allow them to refinance. Once your interest-only period ends, your current lender will likely automatically revert your loan to principal and interest and place you on the standard variable rate, which is unlikely to be the best available in the market place. As long as you’ve done your homework when you first set up the loan, you should be able to comfortable make the higher repayments to include the principal component.

Given that your lender will place you on the standard variable rate, it is always worthwhile having your mortgage broker contact them to seek a discounted rate to ensure that you’re not paying more than you need to be.

Case Study: Gwen currently has two investment properties in Sydney and had her loans structured as interest-only. They both expired and her only option was to allow her loan to revert to a principal and interest loan and make the additional repayments. As commonly takes place, her lender placed her on a standard variable rate, which she managed to have reduced by 1.5% p.a. by making the call to her lender and threatening to take her business elsewhere.

3. Refinance on interest-only basis with another lender

If you find yourself in a situation whereby your current lender will not allow you to extend your interest-only loan, you can always start exploring other options with your mortgage broker. As long as you can comfortably service the loan and meet the new lenders’ requirements, you can effectively extend your interest only period with a new lender. You will need to ensure that you have a strong case for why you are seeking to extend your interest-only loan in the current credit environment, which could be that you’re completing renovations or going on maternity leave.

Case Study: Susan & Greg currently own 3 investment properties throughout the suburbs of Perth, and found that their current lender would not allow them to extend their interest-only period. They were looking to renovate the bathroom on one of the properties and replace the carpet, so required the additional cash flow to cover these costs and lost rental income. After reviewing the credit policy of a range of other lenders with their mortgage broker, they found that they could extend their interest only loan for a further 2 years to cover this gap.

4. Refinance to another lender on principal and interest basis

If you’re not able to extend your interest-only loan or would prefer to revert to a principal and interest loan to take advantage of lower interest rates, you could also consider refinancing to another lender offering more attractive rates and features. You may find that your current lender is not the most competitive in the marketplace, and that there are many better options available. Your mortgage broker will be able to walk you through all of the options available and assess how much you could save by making the change.

Case Study: Jim & Peter own 4 investment properties in Melbourne and Brisbane and had all four of their loans structured on an interest-only basis. While they are both Australian citizens, they are living and working in New York and therefore found it difficult to find a lender that would allow them to extend their interest-only loan. After discussing their options with their current lender, they found that they could obtain a much more competitive interest rate with another lender and therefore refinanced their loan with them.

5. Extend your overall loan period

A further option that you have available, particularly if you’re not able to extend your interest-only loan and will revert to principal and interest repayments is to refinance and extend the total period of your loan. You may find that your current loan term has 22 years to maturity, while you could refinance this and push it out to a 30 year term. This will allow you to reduce the impact of the principal repayments, and you can always adjust this term at a later stage when cash flow allows.

Putting this into perspective, a $500,000 principal and interest loan on a 22 year term would require a monthly repayment of $3,126.40, while if this were extended to 30 year, the repayment required would be just $2,684.11 per month.

Case Study: Julie owns one investment property in Sydney’s eastern suburbs, and found that she did not have the option of extending her interest-only loan. After reviewing her options with her mortgage broker, she found that by refinancing her investment property loan and extending the term from the remaining 10 years, out to 18, she could save a little over $2,500 per month in repayments. She also decided to split the loan into a fixed and variable component to allow her to make additional repayments to the loan once her cash flow allowed.

There are certainly still options available to you that are important to consider when it comes to the expiry of your interest only loan. The earlier you start exploring them and working with your mortgage broker, the more options you’ll find you have to choose from.

Ally Home Loans Pty Ltd is your ally in finance for all of your home loan, investment property, business and commercial financing needs. With our wide range of lending solutions, expertise in financial planning and investment strategies, and extensive experience in working with both Australian residents and Australian expats, we are your partners for your lending needs.

Book an obligation-free, complimentary consultation here today.

Ally Home Loans Pty Ltd is an Authorised Credit Representative (Credit Representative Number – 494608) of My Local Broker (Australian Credit License – 481374). Important Disclaimer: Your complete financial situation will need to be assessed before acceptance of any proposal or product.