Thousands of Australians face financial strain as interest-only period comes to an end

Thousands of home buyers could be forced to sell their home as they find themselves under financial strain when the interest-only period of their mortgages comes to an end.

Interest-only loans are usually offered for five years by Australian lenders, meaning those who borrowed in the 2015-16 calendar year will now have to pay the principal (the actual loan amount) plus interest when the change kicks in over the next year. 

Around 730,000 interest-only loans will switch to principal-plus-interest this year across the country, an analysis of data by finance comparison service Finder has found. 

That equates to around $292 billion in mortgages.

Finder’s Insights manager Graham Cooke said the average loan size was around $395,000 in 2015 and 2016, meaning at today’s interest rates of 4.8 per cent, home owners would face paying an extra $3600 a year – or $300 per month – on that amount.

“Owner-occupiers or investors who borrowed more are in for a bigger surprise, with the increased cost for a $1 million loan clocking in at a huge $789 per month, or $9468 annually,” Mr Cooke said.

While many home owners, including investors, will be looking to refinance to another interest-only loan, some will look to renegotiate the interest rate on their current loan to get a better deal, Mr Cooke says.

Others, however, will be forced to sell their property as they are unable to get refinancing or afford the adjusted repayments.

It could be a large number of people who will have no other option but to sell up, with a 2017 survey by financial services firm UBS showing a third of people with an interest-only loans may not properly understand what it was, nor that they would have to pay extra once the interest-only period ended.

UBS experts feared a number of home owners could end up in financial stress because of their lack of knowledge.

Concerns were also raised at the time about “liar loans” where people had overstated their earnings or lied about finances in a loan application, meaning they would be under greater strain if repayment amounts rose.

Figures released by UBS last year also showed one in three Australians had lied on their applications despite tougher checks by the banks in the wake of the financial services royal commission.

Adding to the woes, interest-only loans were extremely hard to get for owner-occupiers – especially those who were refinancing, associate director of Pro-solution Private Clients Jodi McKeown said.

People needed to be realistic about paying off their mortgage, she said.

“If they’re refinancing for cash flow, it’s a worry,” Ms McKeown said. “They need to ask themselves when it is time to start paying the principal.”

Those heading towards retirement with an interest-only mortgage needed to think about their “exit strategy” as the banks would want to know how they intended to pay off the loan and not carry too much debt when they finished working.

“Investors are OK. The lenders have really started to come to the party and are marketing huge discounts for investors wanting interest-only loans,” Ms McKeown said.

She said some lenders were offering discounts of up to 1.8 per cent for refinancing loans.

“They’re getting really good discounts,” she said.

Mortgage Choice Caroline Springs broker Greg Vine said the popularity of interest-only loans was waning, with most people in the first-home buyer hotspots in Melbourne’s outer west looking to get a principal-plus-interest loan.

As interest rates were generally lower when the principal of the loan was also paid, it was a more attractive deal and allowed buyers to qualify for the First Home Loan Deposit Scheme, he said.

“Looking at our 12-month trend, the numbers have been static for a while, but across the board 10 to 12 per cent of all loans are interest-only,” Mr Vine said. “Anecdotally those numbers have dropped off.”

Investors were most likely to apply for interest-only loans in the area, Mr Vine said, and would need to prove to lenders they could pay back the loan if it were interest-plus-principal before being approved.