So the interest-only term on your mortgage is about to end? Let’s look at your options
Are you on an interest-only loan? While it’s generally investors who are, 1 in 4 IO loans are actually taken out by owner-occupiers. With 200,000 IO loans set to expire in the next few years, these people need to consider their options.
There’s been much brouhaha about people coming off interest-only loans of late. The Reserve Bank has voiced concern that almost $500 billion in interest-only mortgages (or 200,000 loans) are set to expire in the next few years – and that some people will be ill-equipped to start paying off their loan. The RBA estimates the median payment increase will be around $7000 a year.
Investor research company Moody’s has also warned that the number of missed mortgage repayments will increase in the next two years as borrowers convert from interest-only to principal and interest loans.
While it’s generally investors who are in IO loans, 1 in 4 are actually taken out by owner-occupiers, according to the Australian Securities and Investments Commission (ASIC). It’s these people who are most at risk. Some owner-occupiers consider their interest-only loan repayments a bit like paying rent and don’t want to pay more. Others are convinced they can keep extending the interest-only loan period and never pay off debt – believing capital growth in their area will see them through. But, with house prices starting to drop across Australia, this strategy could now prove to be very risky.
If you are in this boat, have a chat to us about your options. We’ve also laid them out below:
Option 1: Get an interest-only extension from your lender
Many lenders will try to keep their customers and offer them a few options. One is to refinance to another interest only product which, from an investor’s perspective, could be the best option for tax purposes. With the Australian Prudential and Regulation Authority’s (APRA) tightening of regulations around interest-only loans in recent years, it’s not uncommon for lenders to stop rolling over interest-only loans. The other issue is, with a decline in property prices, lenders are more likely to want customers to start paying off their loans.
Pro: If you can get your lender to agree to it, this one’s the least hassle.
Con: You’re delaying paying off the principal on your loan and, in doing so, stretching out your mortgage, which might not be the best financial option – this is the reason many lenders won’t agree to it. Plus, regulatory measures introduced by APRA have made it increasingly difficult for borrowers to extend the IO period on their loans for another term.
Option 2: Start paying back the principal with your current lender
When your interest-only term has ended, you will most likely be switched automatically by your lender to a standard variable rate on a principal and interest loan. This means your repayments will rise. Despite paying a higher rate on an interest-only loan, you likely wouldn’t have been paying back the principal, so your repayments would have only had to cover the interest on the loan. Paying back the interest plus principal means your loan repayments will rise.
Pro: In order to keep you as a client, your lender might offer you a great P&I rate. It’s worth asking them or threatening to leave – you never know what they might come up with!
Con: If you’re automatically put on a standard variable rate by your lender, it’s unlikely to be the best rate on the market.
Option 3: Refinance to another interest-only loan with different lender
If your lender won’t let you extend your interest-only loan term, another option is to refinance to an interest-only loan with a different lender.
We can search through thousands of home loan options and find other lenders and rates suited to your needs. At the moment, owner-occupiers will have to meet certain requirements and you’re going to need a very strong case.
It all comes down to the policy of the bank. If you’re looking to do some construction and will have less cash flow as a result, or need cash out to renovate, this might get you over the line. Another good reason might be if you’re going on maternity leave or about to take carer’s leave, both of which will reduce your cash flow. Otherwise, lenders will be reluctant to extend the loan as it’s harder for the customer to service (afford) an IO loan overall than it is a P&I loan because your serviceability is calculated over the remaining principal and interest term.
Pro: You can continue to make interest-only repayments and keep your costs down.
Con: You need a very strong case to argue for another interest-only loan these days.
Option 4: Refinance to a P&I loan with a different lender
With interest-only loans, borrowers often think they’re getting a better deal because they pay less per month and their repayments are 100% tax deductible. But paying off the principal part of your loan means you’re reducing the debt you owe to your lender. If you’ve just been on an interest-only loan for five years, you will switch to a 25-year principal and interest loan. However, to keep payments down, some lenders will let you switch to another 30-year loan term which, essentially, stretches out your repayments and may be more manageable.
Pro: You can potentially negotiate a better rate with a different lender, even if it means refinancing your loan over a longer period.
Con: Your repayments will increase as you will be paying back principal as well as interest. You’ll probably have to do more paperwork and pay government fees to discharge and register the mortgage.
Option 5: Speak to your lender about seeking hardship debt help
If there is an affordability issue, you can speak to your lender about your struggles. They will ask for an update on your income, liabilities, dependent status etc. (If the lender is making any changes to the product you’re signed up to, they should be asking these questions anyway).
If a customer genuinely can’t afford their home loan repayments, the lender can look into hardship debts. They may extend the loan by 12 months to give you time to get your funds sorted. If that fails, the extra time will give you more time to sell the property if that’s the only option for you.
At the end of the day, it’s the lender’s responsibility to come up with a plan.
Pro: You get to keep your house and hardship doesn’t last forever – a few months to 12 months for example. You won’t go into default, so your credit rating won’t be affected.
Con: If you don’t let your lender know about your struggles and miss a few repayments, you’ll get letters and and threats from the bank about possibly losing your home. If you default on your repayments, it might affect your credit rating in some circumstances.
Option 6: Sell or downsize
As much as lenders don’t like to force people out of their homes, another option for people who can’t afford to make their loan repayments and start paying off debt is to sell or downsize. Families go through ups and downs and unforeseen circumstances, such as ill health or injury, which can sometimes get in the way of a family and their mortgage.
But, I would say other people just want more money in their pockets: to pay less each month and to go out to restaurants and enjoy life more. In this situation, a lender is not going to extend an interest-only loan, especially when it’s in the borrower’s best interest to pay the loan down. What will you appreciate more in 30 years? Those countless plates of lobster thermidor or a sleeping in a house you can finally call your own?
Pro: If house prices have increased, you might make some money from the sale and save yourself from ruining your credit score.
Con: You lose the house you bought. If your goal is to own property, then you’re back to square one.
Even though you’ll get short-term gains paying off interest-only, paying down the principal on your loan (which means paying off your debt) is the more sensible option for many owner-occupiers. It gives you a safety buffer in case something unexpected happens, such as ill-health or injury, job loss, etc. It also holds you in good stead if house prices do drop across the country.
Speak to us about your options.
It’s important to note that the information we give here is general in nature – no matter how helpful or relatable you find our articles. Even if it seems like we’re writing about you, it’s not personal or financial advice. That’s why you should always ask a professional before making any life-changing decisions.