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Major banks in Australia gave property investors a reason to rejoice by slashing the rates on interest-only lending. At the beginning of March this year, Commonwealth Bank of Australia (CBA), one of the big four banks, dropped its two-year fixed interest-only rate by 50 basis points to 4.34 percent per annum. Westpac followed suit with a drop of 14 basis points on a similar financial product, as various smaller lenders including ING and Virgin Money also slashed rates on some interest-only loans.

 
Investors rejoice as major banks slash rates on interest
 

2017 was a tough year for interest-only borrowers as APRA announced a 30 percent cap on new interest-only lending in March 2017. As a result, banks increased the rates on interest-only loans aggressively to reduce the demand for the product, in some cases the IO rates were nearly as high as P&I.

However, the banks were not sure how much the rates needed to increase on interest-only loans with respect to other mortgage products to reduce the demand to just below the regulatory cap. Unfortunately, the aggressive rate hikes proved to be too much, bringing the percentage of interest-only lending to less than 20 percent of new mortgages by the end of 2017. As a result, banks currently have enough legroom to grow interest-only lending on their books without exceeding the cap set by APRA.


What does this mean for Australian home buyers and investors?

A lower rate on interest-only loans is good news for investors who would need lesser money to service their mortgage. However, for owner-occupiers who wish to take out interest-only loans, it is crucial to understand the financial product properly before deciding whether it is a good choice for them or not.

An interest-only loan is different from a traditional P&I loan as you only make interest payments, leading to lower repayments for a fixed period. At the end of the interest-only period, the loan reverts to a basic PI loan. Lenders will assess your ability to service the full debt in the 30-year term, resulting in a higher P&I repayment after the initial IO period ends. Consequently, interest-only loans are popular with investors as they offer better cash flow, financial flexibility and tax-benefits to them. However, for owner-occupiers, it is usually better to pay off the interest and principal and reduce their debt quickly. An interest-only loan may only be suitable for owner-occupiers in certain situations. For example, first home buyers can use an interest-only loan with an offset account to make their repayments more affordable in the first couple of years however first home buyers should take advantage of the low-interest rate environment and pay P&I and where possible and consider making additional repayments to get ahead. Despite the perceived benefits, home borrowers who decide to take an interest-only loan must fully understand the financial product and be prepared to pay 30-60 percent higher monthly repayments once the interest-only period is over.


P&I or Interest-Only?

If you are a property investor, an interest-only loan could have several benefits for you. However, for most owner-occupiers, a P&I loan, with added features such as an offset account and flexible repayments, remains the best option. If you think you might benefit from an interest-only loan, we recommend that you crunch the numbers and discuss your situation with a mortgage broker. You can start by posting your query online to have it answered by experts, free of cost, or find a verified mortgage broker in your area, here.

 

By Vidhu Bajaj,
HashChing Content Writer

 

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