Can you refinance an interest-only loan in the current economic climate? 

Interest-only loans are still on the table for home owners and investors, but experts say banks are taking a much closer look at borrowers’ financial stability, especially for investment properties.

Southshore Finance director Michael Coombes says most lenders are open to refinancing, including major banks, secondary banks and non-bank lenders. “But there are stricter requirements around reliance on rental income and holding costs,” he said.

He also warns property investors to be prepared to answer questions around employment stability and COVID-19’s impact on the property’s rental income stream.

“Record low interest rates, particularly some fixed rates, make it attractive to refinance,” he said. “But it’s not going to be an easy process given falling property prices and lender concerns over the impact of COVID-19.”

• A guide to the property market during COVID-19

Refinancing an interest-only loan may be challenging for borrowers affected by the economic impacts of coronavirus, according to loan platform Lendi chief executive and Domain Home Loans director David Hyman.

“Changes to your income such as your tenants not paying rent should be disclosed as part of your loan application,” he said. “Lenders will assess this situation to see if it has a material impact on your ability to service your loan.

“It may be challenging to refinance an interest-only loan if your tenant is not paying rent.”

He recommends investors in this situation speak to their bank.

“They are not taking a one-size-fits-all approach to COVID-19. Most banks will look at each situation on a case-by-case basis and consider various options, which might include extending an interest-only period. Or they might give you some payment relief if your tenants are no longer paying rent.”

There are a number of criteria banks need investors to meet before they will roll over an interest-only loan, says Felicity Heffernan, chief executive of Property Loan Advisor, which specialises in helping investors get finance.

“They want to know why you want an interest-only loan. For instance, you may want to pay interest-only for cash-flow purposes,” Heffernan says.

“You also need to let them know the term you want, which will be between one and five years.

“Lenders also want to know your plan once the interest-only period expires. Most investors say they plan on paying off the debt over the remaining term of the loan,” she adds.

Be aware interest-only loans are more expensive than principal-and-interest loans. The typical rate for an interest-only investment loan is between 3.2 per cent and 3.5 per cent.

The rate for a variable principal and interest investment loan is about 3.1 per cent.

Rates are around 2.5 per cent to 2.9 per cent if investors choose to fix their loan on a principal-and-interest basis.

It is important to think through whether extending your interest-only period is the right strategy for you, says Hyman.

“Plenty of lenders have interest-only products,” he said. “But don’t let interest-only be your default position. More often than not, it’s better to pay down the principal.

“Given record low interest rates, we recommend people look at trying to manage the cash flow on a principal and interest loan.”

Whatever strategy you choose, with rates so low, it’s certainly a sensible time for investors to look at refinancing, especially if they have not asked their bank for a better rate in the past few years.

The payoff can be substantial, says Heffernan. “I have been able to save my clients thousands of dollars by going direct to their bank to ask for a discount or, if they have the ability to refinance, picking up one of the many good deals out there.”