The last 12 months have seen a lot of changes to interest rates on home loans and investment loans and more recently interest only loans getting the regulators attention. Now is the time to review your loan to see if you can reduce your loan rate and perhaps even pay it down faster.
What is with all the interest rate increases this last year?
If you have not noticed already you will soon as most of the banks have made changes to their interest only loan policy and their interest rates because of limits put in place by the banking regulator - APRA. This has lead to a far more complex lending environment and as mortgage brokers, we are able to look to the broader lending market to choose the right loan for our clients.
APRA had this decision because:
- Australia had a high level of interest only loans, this is a risk for them and our housing market.
- Few borrowers are aware just how much more interest they’ll pay with an interest only loan.
- There are many people making interest only repayments even though it’s no longer suitable for them.
So it is time to ask the question, is it time to reveiw your current loan(s) and how they are structured?
Questioning your loan leads to great recommendations
At Focus Property Wealth we use a few simple questions to determine if interest only repayments are suitable for you, our clients. When considering what is important to you , items to consider:
- A lower rate or lower repayments?
- Higher borrowing power or a lower rate?
- Do you need to reduce your repayments in the short term?
If a lower rate or a higher borrowing power is more important to you you, then you should probably be paying Principal and Interest loan repayments.
Owner occupied loans with interest only repayments
As a general rule, this is no a suitable option for most clients and you should only consider this if there’s a good reason to do so or perhaps a short term solution such as when construction a new home whilst renting/living somewhere else.
For example, at Focus Property Wealth we may consider interest only for a home loan if the our clients required repayment flexibility due to their business cash-flow, or if they wanted to keep their funds on standby in an offset account in case of emergencies, or if they wanted to invest their excess funds.
If you are not financially sophisticated or do not have a good handle on your household spending then it’s dangerous. you would be unlikely to benefit from interest only repayments and potentially may not pay off your home loan at all.
Investment Property Loans are currently not desirable to the banks.
Investment loans, particularly interest only investment loans, are currently not in favour with the banks and as a result of APRA's requirement they have increased the rates of these in the last year considerably over and above any reserve bank movements. With this in mind you may consider specialist lenders as well as major ones if you’re going to meet the needs of reducing your loan costs.
What do the numbers say?
Let’s say one of your loans is $500,000 investment loan at 5.1% for 5 years interest only with repayments reverting to principal and interest after this (however most investors renew the interest only period after this). Consider an alternative loan of $500,000 investment loan at 4.3% principal and interest over 30 years.
Firstly the repayments for the interest only loan are $2,125 / month during the interest only period whilst the repayments will be $2,475 per month if the same loan is P&I at the much lower interest rate. Although the regular repayments are higher on the P&I loan the actual interest charged each year is $4,500 less and you will now be reducing your loan balance.
Paying P&I, the customer would make total payments of $890,768 whereas, with a 5 year interest only period they’d pay $944,312. That’s a whopping $53,544 in additional interest! This is conservative as we have assumed after the 5 years they have renegotiated the loan down to the 4.3%. Few customers are aware of just how much more it will cost them.
So although the repayments are higher initially if the loan reverted to P&I after the first five years for the remaining 25 years the repayments would be even higher. Again few customers are aware of this and even fewer consider the effect that this will have on their cash-flow.
What about borrowing power? If a single borrower with an income of $100,000 takes out a home loan, then they can borrow around $620,000 with P&I repayments or $585,000 with a 5 year interest only period. The reason for this is the banks look at serviceability over that remaining 25 years (after the interest only period expires) and so the required repayment amount they allow for is higher. It’s not a huge deal, only a 6% difference however for customers with multiple properties, it can have a much bigger effect.
Existing customers on an Interest Only Loan?
Should you refinance your loans to the cheapest interest only loan available if your not happy with your bank? Probably not as variable rates can be changed at any time, so what’s to stop the new bank putting their rates up?
That means it’s may be time to pay P&I on your investment loan. I know it is against many of the historical property investment books but they were written before this massive difference in interest rates existed and we think it is time to rethink how things are done and consider ditching the interest only loan.
Interested in reviewing your circumstances? Drop us a line or CONTACT US HERE and we will have a quick chat so see if we can add value to your circumstances and get you to your goals much faster.