Interest-only mortgage borrowers in hot water as data shows less financial responsibility

December 5, 2017

Pressure is mounting on interest-only mortgage borrowers as new research shows they tend to be poorer money managers and present as “risk flags” to financial institutions.

An apparent propensity to spend their way further into debt and forgo savings when faced with higher costs, and an increased tendency to sell their property if interest rates rise, make interest-only borrowers a higher risk, according to Morgan Stanley analysts.

The research coincides with a fresh plea from Australian Prudential Regulation Authority (APRA) chairman Wayne Byres for banks to show more caution in their lending practices amid “heightened risk” in the home loan market.

If the exposure to interest-only risks aren’t further reined in by regulators and major lenders, banks could see a rise in non-housing loss rates, according to Morgan Stanley’s AlphaWise research arm, leading to further instability in Australian property and debt markets.

Risks relating to interest-only borrowers are twofold. First, rather than dipping into savings or cutting back on living costs, interest-only borrowers are more likely than others to sell their property if rates rise.

“Interest-only mortgage holders are saving less than principal and interest customers, with this gap most pronounced for owner occupiers.”Morgan Stanley analysts

“This gap is particularly large among owner-occupiers, where [around] 20 per cent of interest-only loan holders would consider selling versus around 5 per cent of principal and interest (P+I) borrowers, suggesting that being on interest-only is a risk flag,” said Morgan Stanley analysts led by Richard Wiles and Andrei Stadnik.

And second, a 53 per cent majority of interest-only borrowers are likely to use credit cards or consumer finance to manage higher costs compared with 29 per cent of principal and interest borrowers.

This is the case despite interest-only borrowers’ mortgage payments being around 40 percent lower than principal and interest on average, according to the report.

“This is consistent with our findings that interest-only mortgage holders are saving less than P+I customers, with this gap most pronounced for owner-occupiers,” the analysts said.

The researchers say APRA could step up its crackdown on interest-only lending, after limiting the amount banks can have on their balance sheets earlier this year.

APRA’s chairman Wayne Byres, meanwhile, has again urged banks to display more caution when considering a borrower’s ability to repay debt.

“The broader environment of high and rising leverage, encouraged by historically low-interest rates, requires ongoing prudence. It is easy to run up debt, but far harder to pay it back down when circumstances change,” Mr Byres said in Sydney.

“Aided by file reviews conducted by external auditors, we have confirmed there is more to do in this area to improve serviceability measures, particularly in relation to the assessment of living expenses and the identification of a borrower’s existing debts,” he said.

His comments come just over two months after UBS researchers said $500 billion worth of Australian mortgages are built on not-completely-accurate applications.

The “liar loans” suggest 26 years of unbroken GDP growth has led to a “large level of complacency within the economy”, UBS economist Jonathan Mott said in September.

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