Interest-only loans under the spotlight

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Posted 4 years ago by Admin

Not all mortgages are created equal, and Kiwi homeowners with interest-only loans could soon feel the flow-on effects of Australian banks cracking down on these loans across the Tasman.

Interest-only mortgages are fairly common among property investors, home owners who have tight cash-flow, and people who are building or need bridging finance. ‘Interest only’ means people pay just the interest owed, and not the ‘principal’ amount of the loan, reducing their payments for a fixed period of time.

Australian regulators are currently limiting the amount of lending banks can issue on interest-only mortgages and are also investigating if banks are inappropriately recommending this type of loan, as there can be considerable downsides for borrowers using an interest-only loan.

At a high level, these types of mortgages delay paying down the principal part of the loan, which leads to larger payments further down the track. For example, if the first five years of a 30 year loan are interest only, the principal then has to paid off in 25 years instead of 30.

The payoff for investors generally comes when they have both personal and investment mortgages - paying the principal off a personal loan can be more tax efficient, as the interest on an investment loan can be tax deductible.

It’s important to note that banks generally don’t allow interest only terms if the LVR is over 80 per cent, and they will often limit the interest-only time period to between two and five years.

Borrowers seeking interest-only terms on an existing principal and interest loan are now being asked to provide additional documentation to the banks in the form of a financial statement of position. Banks will want to analyse a borrower's financial position before granting it. Another potential fish hook borrowers need to remember is that payments can substantially jump up when the loan reverts to principal and interest payments again (as it inevitably will).

Talking through your options with a trusted mortgage adviser when it comes to structuring your loan will help you assess all the options and make the best decision for you, your finances and your family, to avoid any unnecessary pitfalls.

Contact us to discuss your options.

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