Banks to slam brakes on interest-only loans

Borrowers looking to buy a house with an interest-only loan will find it much harder under new rules brought in to curb "heightened risk" in the housing market.

The Australian Prudential Regulation Authority wrote to all banks on Friday, saying it expected them to tighten their lending practices particularly on interest-only and investor loans.

It follows a warning by Treasurer Scott Morrison that regulators needed to crack down harder on high-risk loans, particularly to real estate investors.

"Our objective with these new measures is to ensure lenders are recognising the heightened risk in the lending environment, and that their lending standards and practices appropriately respond to these conditions," said APRA chairman Wayne Byres.

The new rules will require banks to limit the flow of new interest-only lending to 30 per cent of total new residential mortgage lending.

Currently all four major banks are well over the new 30 per cent interest-only quota.

This means lenders will have to put the brakes on interest-only loans to both investors and owner-occupiers.

"There will probably be some people who were looking to get an interest-only loan that can't get it anymore," Omkar Joshi, a senior analyst at Regal Funds Management said.

The Treasurer said the move demonstrated regulators were alive to risks in the housing market.

"These measures will help to provide stability to the housing market by reducing higher risk activity," Mr Morrison said.

But analysts say the rules would not have a big impact on lending to investors.

"Investors get a tax deduction on interest payments, so it makes sense [to lend to them]," he said.

"Owner occupiers get no benefit [from interest-only loans]... They are just a riskier customer."

Shadow Treasurer Chris Bowen said the government needed to abolish negative gearing in order for new rules to have an impact.

"Policies such as negative gearing and capital gains concessions encourage leverage and excessive debt and they should be curtailed," he said.

Under the new rules, banks will also have to tighten lending to customers taking loans that are close to the value of the property they are buying. Banks will also have to keep lending to investors "comfortably" below the existing benchmark of 10 per cent growth a year.

Banks will also be required to ensure that serviceability metrics - factors that influence a person's ability to pay down a mortgage, such as income and interest rates - are set at "appropriate levels" for current conditions.

Mr Byres said lending on interest-only terms represented nearly 40 per cent of residential mortgage lending - a share that is quite high by international and historical standards. He said individual banks would be slapped with new requirements if they went over the new limits.

"[We] will consider the need to impose additional requirements on a [bank] when the proportion of new lending on interest-only terms exceeds 30 per cent of total new mortgage lending.

CBA and Westpac have the highest proportion of interest-only loans, at around 40 per cent, according to analysts.

NAB and ANZ are slightly smaller at 38 and 37 per cent.

Morgan Stanley figures show CBA is well ahead of the pack in terms of interest-only loans to investors, with 17 per cent of its portfolio in this category.

The Commonwealth Bank acknowledged the APRA changes. "We continue to work with APRA to ensure we meet our regulatory requirements," a spokesperson said.

A Westpac spokesperson said customers with interest-only loans already approved would not be impacted.

APRA said banks that were already above the benchmark would have to discuss with the regulator their plans to bring the share of interest-only lending down "as quickly as possible".

It warned banks to be prudent about the risk of people's incomes or expenses changing or being impacted by a sudden rate rise, and to factor reasonable buffers into their loan calculations.

APRA believes interest-only loans are risky because they create additional vulnerability due to the risk of "payment shock" - the increase in payments when loans reverted from interest-only to principal and interest - on top of the normal vulnerability of interest rate increases or house price falls that the rest of the market faces. Last week Mr Morrison urged financial regulators to crack down harder on loans to real estate investors, saying it was no longer just a question of housing affordability, but "frankly, also an issue about household debt ... and the need to make sure that is well-managed from a financial stability point of view".

Shortly after the speech, three of the four major banks raised interest rates on interest-only and investor loans.

Home prices in Australia's biggest cities have jumped 3.7 per cent since the start of the year, with the proportion of settled auctions on the rise as well.

Sydney house prices have jumped 5.3 per cent since January 1, according to the latest data from CoreLogic.

The median house price in Sydney is now $950,000, while the median unit price hit $740,000. Melbourne's median house price is $710,000 and the unit price at $525,000.

Interest-only loans are when a borrower's repayments cover only the interest on the amount borrowed, for an agreed period.

They are considered riskier than principal and interest loans because once the interest-only period ends, borrowers have to pay both interest and principal in less time. It also results in borrowers paying more interest over the life of the loan.

Mr Byres said APRA would continue to observe conditions in the residential mortgage lending market and might adjust the above measures should circumstances warrant it.

Bell Potter banking analyst TS Lim said it was unclear whether the new limits would be enough to cool the market.

"Maybe APRA will have a look and see if this works, and if not they'll come back with more tools," he said.

He said the response by smaller banks was of greater concern because they were an unknown quantity.

"All the attention is on the major banks. It's very hard to get numbers from the smaller banks."

SMH/ March 31 2017

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