A broker has confronted both ASIC and APRA in defence of interest-only loans, after both regulators expressed concern over the rise in these types of home loans – suggesting this may be representative of a broader trend towards risky lending practices.
In a letter obtained by Australian Broker, Ray Weir, director of Finance Solutions WA, hits back at APRA and ASIC, saying there are many logical – and safe – reasons as to why a borrower takes out an interest-only loan.
One reason, according to Weir, is when it is an investment property and the interest is tax deductible.
“…the principal amount is never intended to be amortised. The best advice to such borrowers is to utilise surplus cash flow to instead concentrate on repaying non-deductible ‘bad debt’ such as an owner-occupier home loan or other personal debt.”
When buying a property for owner-occupation, Weir says an interest-only loan can be beneficial if the borrower wants to minimise the monthly commitment before they intend to substantially reduce the loan.
“This method of financing is often used by migrants wishing to buy their first home in Australia, before they sell their former overseas residence when the time is right. Anyone intending to make a sizeable reduction in a proposed new home loan within 12 months, for whatever reason, often request an interest only loan for the first year, with the subsequently reduced balance converting to lower principal and interest repayments after 12 months.”
Interest-only loans are never a long-term plan, says Weir, but can be a practical option in the short-term to free up cash for business purposes or other investment, or to accelerate the payment of other higher-interest rate debt. He also says it can actually help borrowers pay off their loan cheaper and faster.
A high income borrower can take out an interest-only home loan, but still make regular lump sum principal reductions. According to Weir, this will lead to a larger reduction in the monthly interest commitment when compared with fixed monthly repayments on a standard principal and interest loan.
Alternatively, if a young couple take out a ‘Parental Guarantee Loan’ – whereby they can avoid LMI by borrowing up to 80% in one loan and the remainder in a second, smaller loan using their parent’s property as security – then taking out an interest-only loan for the smaller loan will help them pay off the larger loan quicker.
“The primary loan would be repayable on the principal and interest basis over 30 years, while the second loan could be interest only, allowing accelerated repayment of the principal amount while consequently reducing the monthly interest commitment, thereby repaying that loan prematurely and thus releasing the parent’s property from security early,” the letter read.
