Interest only mortgages, the new high LVR loans?

The big banks have nearly 25% of their mortgage books paying interest only. Gareth Vaughan asks whether this is good for financial stability

10th Nov 14, 2:03pm by Gareth Vaughan

By Gareth Vaughan

This Wednesday we'll get a detailed review of the Reserve Bank enforced restrictions on banks' high loan-to-value ratio (LVR) residential mortgage lending, - from the Reserve Bank.

The review will come in the Reserve Bank's bi-annual Financial Stability Report.

As the Reserve Bank contemplates potentially easing the hand brake and letting banks do a bit more high LVR lending than the 10% of their new home loan flows they're currently limited to, Governor Graeme Wheeler and his team may wish to contemplate whether another type of lending warrants similar treatment to the high LVR stuff.

I'm talking about interest only home loans, where borrowers pay only the interest owing each fortnight or month, but nothing off the principal. The recent annual result from the ANZ group disclosed 22% of ANZ NZ's home loan portfolio was paying interest only. BNZ's parent National Australia Bank disclosed a remarkably similar figure of 22.4% for its New Zealand portfolio.

Meanwhile, a Westpac NZ spokeswoman told me last week about a quarter of her bank's portfolio is interest only, and a Kiwibank spokesman put his bank's at 10% to 12%.

An ASB spokeswoman would only say; "Unfortunately, ASB is unable to release interest only figures relating to its home loan portfolio to the public domain at this time."

Based on these figures from the biggest five mortgage lenders, a rough - and probably conservative - estimate could be that the equivalent of 20% of New Zealanders' $194.521 billion of home loans are paying interest only. That's $38.9 billion worth. A figure of 25% gives about $48.6 billion.

On the eve of the introduction of the LVR restrictions, 23.8% of ASB's home loan book was at LVRs exceeding 80%. ANZ was at 22.8%, Westpac 22.8%, Kiwibank 18.8% and BNZ 15.2%. Percentage wise, some of those figures are remarkably similar to the interest only portion of some of those banks' home loan books now. (A year of LVR restrictions has seen ASB's high LVR loans reduced to 20.31% of its total).

What we don't know is how many mortgages are currently being written as interest only loans. Apparently they're running at about 30% of new lending in Australia. In New Zealand, as reported by the Sunday Star-Times yesterday, we know Westpac is now offering 30-year interest only mortgages targeted primarily at property investors, suggesting this will be an area of growing interest (no pun intended) among at least some of our other banks too.

'Preferable for people who aren't averse to risk'

But do high volumes of interest only loans pose similar threats to the stability of the financial system as high LVR loans?

Interest only loans can be helpful. As the Kiwibank spokesman put it; "It can help people get through temporary periods of financial hardship."

Of its 30-year interest only loan offer Westpac says such loans keep repayments to a minimum, and help maximise cash flow which the borrower can use to help pay off their own home first. The optional 30-year term means borrowers don't need to worry about the cost and hassle of renewing their loan again in five to 10 years like they do with other banks, Westpac adds. And borrowers can restructure the loan to start paying off the principal whenever they're ready too.

"Interest-only loans are often used by people who are saving for their next cash deposit, and who are confident in the long-term capital gains of their property - expecting that the sale of their property will take care of their loan principal," says Westpac. But it also warns; "This approach does involve risk so it might be preferable for people who aren't averse to that."

An obvious downside is if you borrow $300,000 and pay interest only for say, five years, in five years time you'll still owe $300,000. And you'll have to pay that $300,000 back at some point. What if the value of your property falls rather than rises? Here's one example of this happening in Australia.

Similar dangers to high LVR lending in bulk?

So as Graeme Wheeler, his deputy Grant Spencer and their team put the final touches on their LVR restrictions review, they ought to pause and consider the interest only scenario too. Below is a reminder of what Wheeler said in his August 20 speech last year announcing the introduction of the LVR restrictions.

"High LVR lending, as reflected in mortgage lending to borrowers with less than a 20% deposit, has constituted around 30% of new mortgage lending in recent months – up from 23% in late 2011. This high LVR lending is a significant factor behind the buoyant housing demand in some regions."

"These (LVR restrictions) are designed to help slow the rate of housing-related credit growth and house price inflation, thereby reducing the risk of a substantial downward correction in house prices that would damage the financial sector and the broader economy," said Wheeler.

Does strong growth of interest only lending not create similar dangers?

A spokesman says the Reserve Bank has been collecting data on bank interest only loans for a few months and plans to start publishing this sometime next year. Some thorough analysis of this, potentially leading to restrictions on banks' interest only home lending, may be called for.

This story was first published in our email for paying subscribers early on Monday morning. See here for more details and how to subscribe.

We welcome your comments below. If you are not already registered, please register to comment

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.

31 Comments

by Boatman | 10th Nov 14, 2:16pm 1415582166

This is really dangerous , but likely to be still cheaper than renting in the long - run if the floodgates of migration are left open ........

by Boatman | 10th Nov 14, 2:19pm 1415582344

On re-looking at this , one needs to be careful , because in flexible home loans some people have a facility to only service the interest , so the data could have some funnies in it , because they (borrowers ) may deposit surplus cash into the Mortgage and then draw it out to pay tax , etc

by KH | 10th Nov 14, 3:49pm 1415587768

Yes thats me Boatman. And useful it is for me in the businesses. Especially around tax.

But it's still a cancer in the system, when banks do all they can to have people never repay loans. For those in a simple residential setup, they need to be paying down that mortgage, for their own best interest and in the interest of the country.

by raegun | 10th Nov 14, 3:17pm 1415585876

Looks like the banks are getting into the landlording business to me. But at least you'd be able to have pets, make a garden, hang pictures on a wall, paint the kitchen and call it home, eh?

by KH | 10th Nov 14, 3:58pm 1415588314

It's dangerous stuff and will come to a sticky end at some time. Trouble is that the incentive within the systems are all wrong for banks and employees.

As an employee, you are best to do all this crazy business, and take the salary or bonuses immediately, as there is a good chance that it might be 10 years before it all comes home to roost. And you will be long gone.

As corporates, it seems banks are going for the profits in the immediate sense. And if they get caught out financially, well that's then. So why worry.

by pythagoras | 10th Nov 14, 5:17pm 1415593056

With interest rates and inflation both relatively low, there is not a lot of difference between an interest only loan and a 25 year loan.

For example, say $500,000 is borrowed at 5.5%.

Interest only: after 5 or 15 years, the amount owing is still $500,000

25 year loan: after 5 years, the amount owing will be $446,357

25 year loan: after 15 years, the amount owing will be $282,921, still a LONG way to go!

In the past, borrowers have benefited from moving to higher incomes in the future, through a combination of job promotions and inflation i.e., general wage and salary rises. It follows that loan repayments can be accelerated and eventually repaid in full.

Now, with low inflation and huge loans (in terms of ration of loan value to income), the debt is not likely to inflate away and will remain large.

Use a calculator, such as

http://www.goodmortgage.com/Calculators/Remaining_Balance.html

if you are thinking of taking out, or already have a loan.

by steven | 10th Nov 14, 6:03pm 1415595799

Im god smacked ppl are being this stupid, unless its because they are gambling on a quick % inside 2 or 3 years and sell to a greater fool, payback the capital and sit on 20% profit.

It reminds me of the 1920s when ppl got into debt to buy shares...

greed,

crazy.

regards

by Chris-M | 10th Nov 14, 5:56pm 1415595418

We really getting into dangerous territory now. I noted in the weekend that Bill English admitted that he was hoping that government measures would actually reduce Auckland house prices. (but not of bubble bursting proportions) I must admit that I was a bit surprised. Whereas there is an implied intent to do so by ramping up supply, to come out and say it is another thing. A lot of first time buyers are going to loose their equity which is sad but unfortunately inevitable because at some stage this craziness has to return to reality. Perhaps this was a warning shot to try and cool the out of control situation.

High LVR restrictions may well be protecting the long term interests of first time buyers.

by steven | 10th Nov 14, 5:59pm 1415595599

Agree

by muntijaqi | 10th Nov 14, 8:11pm 1415603474

I agree with your comment.

I am likely to be first home buyer eventually (not at these prices though) and I don't see high LVR restrictions as a bad thing but as a thing that makes me think twice whether apart from being able to afford the mortgage I can really afford the price.

It's insane that interest-only loans are allowed when they can put the whole system at risk.

So correct me if I'm mistaken:

A bank invents the amount of money that puts in the system. Lets assume they type into their computer $1,000,000 that magically appear in the system.

Then the borrower is allowed to pay only the interest for certain number of years. Interest that it's the main benefit of the bank, who lended the money they didn't even have.

Then the house prices go down, the borrower looses his job and becomes unable to pay the mortgage in a situation where we are already with oversupply.

Who do we think will suffer the consequences? Not just the borrower but the whole economic system. We all will.

by Chris-M | 10th Nov 14, 8:27pm 1415604424

I need to correct myself. Nick Smith not Bill English

by steven | 10th Nov 14, 6:05pm 1415595945

Interest only is utterly insane...IMHO.

regards

by Alter Ego | 10th Nov 14, 6:08pm 1415596093

I think the yanks called it sublime, or sub-prime...or some such label.

by RDee | 10th Nov 14, 6:10pm 1415596251

Yawn.... big deal. 30 year interest-only loans have been available from Westpac for years. Great tool, allows the borrower to decide when the best time is to pay back principal. Think I took one out about 5 years ago.

Besides, what's the difference between a 30 year interest-only loan, and a non-reducing revolving credit ..................... nothing. Also been around for donkey years.

by muntijaqi | 10th Nov 14, 8:04pm 1415603058

Considering that for every new loan the banks create money out of nothing (bringing future wealth to the present and expecting people to generate it with real value_WORK), these interest-only loans is the craziest most speculative thing ever.

Be careful first-home buyers, you might loose it all when the price adjustment happens. Be careful New Zealand, you are putting the whole economic system at risk by allowing private greedy entities like banks to do such things.

In case it wasn't clear this is all a whole pyramid scheme at the expenses of the newies joinning the action, a game for speculators and fools. The longer it lasts the stronger the fall. Unfortunately not only the players will suffer the consequences..

PS: High LVR restrictions are not only necessary but healthier in the long term. Better not being able to afford a mortgage for overpriced houses than being able to take on the mortgage but not being able to face the payment of these overpriced houses when the bubble bursts. It's a shame they're already talking of relaxing these requirements.

by BigDaddy | 10th Nov 14, 9:11pm 1415607060

Well said.

I say make the LVR's restrictions tougher still as they greatly assist in putting more rent into the pockets of superior classes.

The ragged poor must live somewhere and not get ideas above their station .

by WrecklessNZ | 10th Nov 14, 9:18pm 1415607519

Rent to landlords or interest to banks, does shifting from one to the other really make a difference?

by raegun | 10th Nov 14, 9:42pm 1415608963

Yes, it does, it makes a very important difference, banks do not tell you that you cannot have pets, or dig a garden, or hang pictures on the walls, which may not seem much to a number cruncher, but it sure as hell makes a big one to someone who wants somewere to call HOME

by WrecklessNZ | 10th Nov 14, 10:10pm 1415610621

Fair enough.

by WrecklessNZ | 10th Nov 14, 9:22pm 1415607748

Can someone clarify for me what happens at the end of the 30 years? Is it just assumed by then that the debtor will have another plan lined up? Refinance with a new loan (either another 30 years interest or one with pay-off terms) or sell and pay off the principal?

The difference between this and a loan where the terms include paying off the loan would be that this takes to the extreme your need to assume that house prices always go up?

Perhaps the 30 year part means that even if you go underwater for a couple of downturns you'll probably be ok in the end?

by steven | 11th Nov 14, 7:12am 1415643126

My understanding is often commercial property is interest only mortgage? I think the idea here is simialr. This mortgages are not for 30 years, they are for maybe 3~5 years. So the idea is I think make a quick capital gain by selling to a greater fool, pure speculative IMHO. What is shocking is the huge % there is of it. I cannot see how this is anything but pure stimualtion of the market driving it upward, really stupid if so. Then of course the ppl writing the loan are in it for the bonuses today and not tomorrow.

regards

by Your Landlord | 11th Nov 14, 10:35am 1415655337

Yup steven... life's great for landlords.

by raegun | 11th Nov 14, 12:02pm 1415660561

Which is why some very major changes need to be made so that it isn't so much any more, you know, level the playing field and all that, the sooner the rentier class is dismantled the better

by Your Landlord | 12th Nov 14, 9:15am 1415736907

No hope raegun... see the report in today's NZ Herald about a surge of borrowing by home owners who are now richer.

See... it's not just good honest landlords who benefit from rising house prices.

by raegun | 11th Nov 14, 12:02pm 1415660561

Which is why some very major changes need to be made so that it isn't so much any more, you know, level the playing field and all that, the sooner the rentier class is dismantled the better

by cowboy | 11th Nov 14, 12:41pm 1415662869

Interest Free, normally 30 day to 10years period.

The principle comes due at the end of the period.

That's it. Simple as.

and yes, sorting some refinance, bridging finance, or having a good liquid pool of cash to pay all or most of it back is required.

but interest only is the normal in business, because at the end of the period, it is considered that you'll just reborrow what you require in long-term debt, and either payoff or overdraft/fast repayment a portion of the original debt. well worth doing, because often you really aren't going to pay back the majority of your debt each 3-5 yrs, so just stick on a nice solid interest only, and hammer down the working part of the loan.

by kpnuts | 10th Nov 14, 9:36pm 1415608615

statistics as we know dotn paintthe full picture - i have two interest only loans as well as a revolving loan and then one repayment loan - that loan is being repaid at nearly $3,000 a month but the stats would no doubt see this as 75% on interest only!

by steven | 11th Nov 14, 7:13am 1415643234

but what picture does it paint?

What is your reasoning for doing this?

regards

by Taxman | 11th Nov 14, 10:24am 1415654657

Pretty obvious I would have thought, it normally depends on how you earn your money i.e. lump sum vs regular salary. You pay can pay less interest this way if you have your main portion in short term low interest (the amount you know you will not repay in any given fixed term portion) and then the amount you "think" you can pay in revolving.

For example,

I normally repay roughly 100k a year so I always have that revolving while the main portion is in the lowest possible interest rate for fixed term at interest only. I would be captured by these stats except my mortgage will be paid off in 3 years.

For someone who earns regulary the optimal is to obviously set repayment amounts on a fixed term to exactly the maximum amount you can afford. This however is quite difficult for most people to calculate, I would say it easier to have fixed repayments at the minimum amount you know you can afford without risk i.e. if an unexpected payment comes up and then use either a single repayment on your fixed term (most banks allow a single repayment of up to 5% with no early repayment fee) or a small revolving/floating amount.

by fat pat | 11th Nov 14, 10:45am 1415655920

Annual Auckland house price inflation exceeds most peoples annual income, and therefore Auckland professional DINKS have been under tremendous stress to take insane long term risks with leveraged property investments. National’s got their foot hard on the economic accelerator with zero regulation of foreign capital flows into the property market, and immigration is set at max. Thats out of step with other OECD countries. If it all blows up it will be nationals fault.

by Stephen Hulme | 11th Nov 14, 11:05am 1415657146

Annual Auckland house price inflation exceeds most peoples annual income, and therefore Auckland professional DINKS have been under tremendous stress to take insane long term risks with leveraged property investments.

And all because the National Government turned NZ bank depositors' savings into potentially extinguishable bank equity, so the inevitable insolvency event will encompass the whole community with no legacy reserves to rebuild financial functionality without recourse to domineering foreign overlords - our banks' Australian parents and the IMF etc.

Local Aussie banks would never risk lending under current terms if default recourse demanded access to the capital resources of the parent institution.