Interest-only loans come under the spotlight

Across the ditch, the high level of interest-only lending for residential mortgages has been making waves in recent weeks.

At nearly 40% of total bank mortgage lending, the Australian Prudential Regulation Authority (APRA) has taken decisive action to combat the potential risk.

APRA has now instructed the banks to limit the flow of new interest-only lending to 30% of total new residential mortgage lending.

Additionally, the Australian Securities and Investments Commission (ASIC) has announced targeted industry surveillance to see if lenders and mortgage brokers are “inappropriately recommending more expensive interest-only loans”.

These developments have prompted renewed analysis of the state of interest-only lending, particularly for property investors, in New Zealand.

New data from the Reserve Bank shows that, as at February this year, residential property investors were responsible for 28.8% of outstanding mortgage loans.

Within that figure, 42.4% of the outstanding loans to investors were interest-only loans.

When it comes new interest-only lending, Reserve Bank figures show that, in February, interest-only lending amounted to about 33% of total new lending.

Over half of new lending to investors was interest-only lending in February but, overall, the share of new lending going to investors has declined to around 26% (from 38% before the latest LVRs).

This data indicates that interest-only lending in New Zealand is not at the levels seen in Australia, but that many investors continue to have a liking for interest-only loans.

Massey University banking expert David Tripe said there are issues around interest-only loans in Australia, where they are widely used for tax deduction purposes.

“But I don’t think people do that to the same extent in New Zealand.”

Australian banks have been told off, by the Australian authorities, for making too many interest-only loans - and there are implications for New Zealand because of that, he said.

“The New Zealand banks tend to take their cue from their Australian parents and, as they have been told to tidy up their act, there is likely to be some impact from that here.”

“We have seen a tightening in other lending areas in response to Australian circumstances. It is evident, for example, in the tightening up of lending to developers.”

While the Reserve Bank is not keen on interest-only loans as they increase risk, the much higher LVRs in place in New Zealand as compared to Australia, mean some of that risk is mitigated here.

Tripe said that, none the less, even if the Reserve Bank doesn’t put pressure on the banks over interest-only lending, the Australian parent banks will and there will be some impact from that.

Given the current Australian crackdown, talk about the issues created by high levels of interest-only lending is inevitable, but property industry figures believe the situation is different in New Zealand.

Mortgage broker Geoff Bawden, from New Zealand Property Finance, said his gut feeling is that there has been more of a responsible approach to such lending taken in New Zealand.

“You have to look at your own portfolio book and assess if it is a risk. And, within our group, I don’t think it is. We take a responsible approach to people who want interest-only loans.”

There are a lots of legitimate reasons why investors like interest-only loans – from maximisation of tax advantages to cash flow benefits.

“So we ask why someone wants an interest-only loan and talk about it with them. Often we find it tends to be a short-term approach, not a long-term one.”

He suspects there will be some adjustments to the way interest-only lending works here in New Zealand because of what is happening in Australia.

“We tend to follow suit. There have been some pretty intense restrictions on it in Australia. So there is likely to be a trickle down tightening effect here.

“In fact, there have already been some restrictions on rollover interest-only money.”

Different times make for different approaches, according to investor Mark Honeybone, from Property Ventures.

He said he was an advocate of interest-only loans 10 years ago, but the lending environment has changed considerably.

“Now, it is far more important for an investor to be paying off the principal on a mortgage as quickly as possible because, under the new LVRs, you need to build up as much equity in a property as possible to leverage off it.

“If an investor wants to continue developing their portfolio these days, they need to build the equity they have in their existing portfolio.

“Interest-only loans don’t allow you to do that. The only way you can do it is by paying down the principal.”

He thinks that, given what is happening in Australia, the New Zealand banks will tighten up on interest-only lending and that will probably hurt some investors.

“But you have to go with the flow of what the banks are doing and work with them. So, at the moment, interest-only loans are simply not the best way to go.”