On the 31st March 2017, the Australian Prudential Regulation Authority (APRA) wrote to all authorised deposit taking institutions (ADIs) advising that in order to reinforce sound residential lending practices, that APRA expects ADIs to limit new interest only lending to 30% of new residential lending.
Since that advice from APRA, in order to moderate demand, the majority of banks have increased the interest rates applied to interest only loans for both home and investments loans. With these new higher interest only interest rates, now may be a good time to review whether an interest only loan is continuing to meet your needs and objectives.
Scenario for consideration :
As an example, Mr. & Mrs. Smith borrow $500,000 to purchase an investment property, the loan is structured as a investment loan, with a interest only rate of 5.45% during the initial interest only term of 5 years, the clients will therefore have monthly interest only repayments of $2,270.
In comparison, Mr. & Mrs. Jones borrow $500,000 to purchase an investment property, however they structure the investment loan as a principal and interest loan with a 30 year repayment period. With a interest rate of 4.94%, they will have monthly loan repayments of $2,665.00. While these loan repayments are $394 per month more than the Smith’s interest only repayments, the Jones are reducing or amortising their investment loan by $607 per month. This amortisation of $607 is made up of a principal reduction of amount of $394 per month as well as a saving arising from the lower interest rate of some $212 per month.
It can be useful for Mr. & Mrs. Smith to understand how much extra they end up paying in total interest over the full 30 year term of a loan when they structure an investment loan with an initial interest only repayment period, compared to having the loan structured on a principal and interest repayment basis from the start of the loan.
For example, using one Bank’s current interest only investment loan interest rate and the corresponding principal and interest rate above, clients will pay an extra $48,210 in interest costs where they structure the initial 5 years of the loan on an interest only basis. If the clients choose to have the initial 10 years of the loan on a interest only repayment basis then they will pay an extra $100,785 in total interest costs over the full 30 year term of the loan.
As outlined above while Mr. & Mrs. Smith will have lower repayments for the initial interest only period, in the above example monthly interest only payments of $2,270 for either the 5 or 10 year period, the principal and interest repayments will be $2,905 per month over the remaining 25 year term, or $3,283 per month over the remaining 20 year term.
The benefit of saving some $394 per month during the interest only period needs to be weighed up against the increased monthly principal and interest repayments of $634 over 25 years, or $1,012 over 20 years once the loan has converted to a principal and interest repayment structure.
Allowing Planning Partners to assist you with a review of your existing home and investment loans will provide you with the confidence that your existing loans are meeting your goals and objectives and that your finance provider is providing you with a competitive loan interest rate.
We would also like to note that the above interest rates are indicative interest rates from one provider and that the current loan market is very competitive and we work to ensure that we provide our clients with very competitive finance offerings.
If you would like to have an initial confidential discussion about your existing loan structure and provider, please do not hesitate to contact our Manager – Mortgage Services, Phillip Olson on 03 9830 0366 or by email to firstname.lastname@example.org.