Lenders warned over interest-only loans

AUSTRALIAN lenders are falling short in their responsibilities when assessing eligibility for interest-only home loans, the financial watchdog has found.

The Australian Securities and Investments Commission has released a report into interest-only home loans, arguing lenders need to lift their standards to meet consumer protection laws.

ASIC reviewed 140 consumer loan files from 11 lenders, including the big four. It found in 40 per cent of cases, affordability calculations assumed the borrower had longer to repay the principal on the loan than they actually did.

In more than 30 per cent of cases, there was no evidence the lender had considered whether an interest-only loan met the borrower’s requirements, and in more than 20 per cent of cases, lenders had not considered the borrower’s actual living expenses, instead relying on expenditure benchmarks.

ASIC said demand for interest-only loans had grown by around 80 per cent since 2012. Interest-only loans are popular for investors looking to minimise their initial holding costs while building up capital, but will result in the borrower paying significantly more over the course of the loan.

For example, an interest-only period of five years on $350,000, 25-year home loan at a rate of 5.5 per cent would add around $29,000 to the total cost of the loan, compared with someone who paid principal and interest right from the start.

“Interest-only loans may be a reasonable option for some borrowers,” ASIC Deputy Chair Peter Kell said in a statement. “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.”

Justin Davies, finance editor with Canstar, said while interest-only loans might be a good idea for investors, the concern was for owner-occupiers using them to lower their repayments.

“The bottom line is if they’re doing it to make their home loan more affordable, they should really be questioning whether they can afford it in the first place,” she said.

“People just need to be really clear about why they’re taking on an interest-only loan. If it’s to maximise their tax deductions that’s probably sensible, but if they’re doing it to ease up their cashflow it might not be a good idea.”

The report makes a number of recommendations, which the lenders have already agreed to, including ensuring loans align with consumer requirements and objectives, using actual expenses rather than benchmarks, and including buffers for future interest rate rises in affordability assessments.

“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,” ASIC said.

news.com.au/ August 20, 2015