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With a huge percentage of interest-only loans expiring between 2019 and 2020, borrowers could be facing an issue on the extension of interest-only periods. How can they navigate the still-tight credit environment in 2019?
After the interest-only cap was removed and the banking royal commission concluded by the end of 2018, experts believe that lenders will start to pull back and ultimately make the process easier for borrowers in order to regain consumer confidence.
However, as the strict serviceability assessment remains, borrowing may not be as easy as most people expect.
A huge number of interest-only loans are expected to expire between 2019 and 2020 and, thus, become standard principal-and-interest loans as application for the extension of interest-only periods remain under stringent guidelines.
Investors, in particular, might be getting the short end of the stick, according to former Federal Treasury economist Redom Syed.
“There’s an interest-only expiry issue that’s really coming to play and this is really specific to investors. Why? Because investors ramped up credit in 2014 and 2015. Interest-only loan figures were at record highs for those years and 2019 and 2020, to some degree, is five years after the period where those loans originated. That means, a lot of investors may face interest-only loans expiring this year.”
“That in itself may not be a problem, but it is really important for investors to be aware of this and to manage it. Part of that is being aware of your financial position and your serviceability and your borrowing capacity and your equity position,” Mr Syed said.
As such, he reminds investors to continue doing their due diligence in order to successfully manage and grow their portfolio as they move forward in 2019.
With loan applications subject to new lending standards created as a result of the banking royal commission and the regulatory interventions from the Australian Prudential Regulation Authority, the process of extending interest-only loans could be a little more complicated nowadays.
Investors who want to extend their interest-only loans this year to manage their cash flow and improve their overall income will have to ‘pass the 2019 hurdles’, Mr Syed said.
“You can’t just go to the bank and say, ‘Can I please get an interest-only extension?’ The bank is going to say, ‘We need to reassess you and see what your position is like.’”
“They’re not going to reassess you based on your 2014 lending calculator and lending policies. They’re going to assess you based on today’s lending conditions, which are drastically different over last few years, so they need to be aware of their financial picture in today’s environment, not the way it was a few years ago – those are different.” according to the economist.
Getting rejected by banks
While getting interest-loan only extensions approved remains possible, chances are a number of investors will be rejected following the reassessment.
Mr Syed said that a rejection, first and foremost, is a sign that the investor needs to review their debts.
Whether the borrower is asking to refinance the loan back to a 30-year term with a new interest-only period or requesting that the bank re-issue an extended interest-only term, they should be able to comply to the current serviceability assessment, which looks deeply into their living expenses.
Moreover, upon rejection, borrowers should take the time to ask around for pricing to get the lowest interest rates once they apply for reassessment again.
Moving forward, Mr Syed advised them to take the ‘secondary step of testing their borrowing power with alternative lender’.
According to him: “Where someone can’t refinance or extend their interest-only term with their existing bank, it doesn’t mean that they have no options. They just have to test their eligibility with alternative lenders.”
“While a lot of banks have pushed the hurdles up in 2019, not all banks have done that. If you could get finance in 2014, there’s probably options available to you in 2019, although they’re likely going to be non-bank lenders who have filled up this vacuum.”
“The interest rate might be marginally higher so you’d have to weigh up the pros and cons of doing it. Generally, you’re likely to have options with alternative lenders.”
In today’s tight credit environment, it’s going to be all about finding where to fit in, Mr Syed highlighted.
As the expiration of interest-only terms comes close, Mr Syed strongly encouraged investors to be prepared in terms of cash flow and safety buffers. That way, if their application for extension gets denied and they don’t immediately find an alternative lender, they don’t take too much of a hit financially as their loan becomes a standard principal-and-interest loan.
Applying for loans with alternative lenders does not differ too much from applying for loans with banks, Mr Syed said.
“They ask for the same documents, they go through the same process, they even do the same checks.”
The main difference is the borrowing capacity that they have, particularly for investors, which is significantly higher than traditional lenders.
According to Mr Syed: “Because their borrowing capacity is better, it means that an investor can pass their criteria. When you pass their criteria, it means that they’re happy to give you an interest-only term. That’s the key difference.”
“They go through the same checks, the same process for investors. It’s just that the product is going to be different and the branding of that product is going to be different, too.”
The looming expiration of interest-only loans stan as a great time for investors to reassess their portfolio in order to make the best decisions regarding the next steps to take in their wealth-creation journey.
Whether the investor stays with their current traditional lenders or seeks the assistance of alternative lending institutions, Mr Syed strongly advise doing ‘financial assessments’ to be able to continue growing their portfolio without overcapitalising.
For investors who are unable to refinance, the economist recommends doing a thorough ‘health check’ on their portfolio to determine the next best steps to take.
One of the ways to restart their property journey is by reviewing the level of their debts.
Mr Syed said: “If, for example, they have four or five properties going to principal-and-interest within six to 12 months, that can be a little bit of a cash flow headache for them.”
“To manage that situation, it doesn’t mean that they need to get rid of all their properties urgently. There’s no, there’s no need to do that and there’s no pressure to do that either. What it would mean is to work out what level of debt is actually affordable for you under today's lending conditions.”
“If you bring your debt levels back down to your affordability limits, you’ll find that the banks are now happy to lend to you again. It’s just about moving into a position where they accept you.”
The economist also encouraged investors to work with professionals such as mortgage brokers and accountants to further understand their borrowing capacity as well as the options available for them across the market.
“There are different levers that are involved, like ‘Which are the costs that are going out versus the cost that are coming in?’ ‘Would that involve tenants,’ and other moving parts like that.”
“A little bit of homework or a little bit of management – that’s what investors really need,” Mr Syed concluded.