APRA Now Officially Restricting Interest-Only Loans

Australian regulators have decided to intervene in the property market again, in response to the continued strong growth in house prices, particularly in Sydney and Melbourne. The Australian Prudential Regulation Authority (APRA) has placed additional restrictions on Australia’s banks and other deposit-taking institutions.

It has been widely reported that APRA has written to all lenders requiring them to restrict interest-only loans to a maximum of 30 percent of their loan books. The reality is, APRA does not have oversight of all lenders. It only oversees those that accept deposits, so APRA can only force these institutions to adhere to this new 30 percent interest-only rule.

You should recognize that the decision was not solely made by APRA. The Council of Financial Regulators (CFR), also contributed to the decision. The CFR is a non-statutory body whose membership includes the Reserve Bank of Australia (RBA), APRA, the Australian Securities and Investments Commission (ASIC) and the Treasury. It was APRA that sent instructions to the deposit-taking institutions on behalf of the CFR.

Why APRA Is Targeting Interest-Only Loans

Publicly, APRA has stated that close to 40 percent of bank-owned residential mortgage lending stocks are interest-only. They added that this is high by international and historical standards, therefore warranting the imposition of such restrictions to recognize the heightened risk in the current lending environment.

According to APRA chairman Wayne Byres,

“APRA views a higher proportion of interest-only lending in the current environment to be indicative of a higher risk profile.”

These comments blatantly ignore the facts that interest-only loans only set the minimum repayment and that Australians are increasingly ahead on their mortgages. In terms of international comparisons, it also ignores features like offset accounts and redraw, which are not available everywhere. Offset accounts are virtually unheard of in the United States.

More likely, the real reason is because the government is wrestling with the question of how to slow down growth in housing prices, without raising interest rates. It has chosen to attack property investors as a soft target. Perhaps this is being overly cynical, but I would suggest it probably helps that forcing investors to pay down the principal on their loans would reduce negative gearing credits, resulting in more personal tax revenue to the government.

Why Investors Should Care About These Changes

Interest-only loans will probably become more difficult to come by. This is significant, not because there is a problem with paying down debt, but because there is a significant cost involved if you cannot choose to pay down more expensive debt first.

This is the base principle of efficient loan structuring.

If the government mandated all loans to be principal and interest-only, there would be a considerable cost to individuals, and a bonus in extra taxes going to the government. Ironically, for many investors, the inability to use interest-only loans would make the process of paying down debt slower. The reason is because investors would be paying more in taxes with money they could have used to reduce debt.

The Implications for Our Property Market

It is unlikely that this policy will have a long-term impact on the property market. The continued actions of the various arms of the government to restrict lending, particularly to investors, suggests a persistent reluctance to raise interest rates.

It is important to note that again this week, the RBA left rates on hold. The RBA’s policy statement cited continued low employment and concerns about slow wage growth. Any increases in interest rates would invariably have a negative impact on these indicators.

History has shown interest rates to be a major factor in the performance of property as an investment. Low rates will continue to drive the strong performance of this asset class, so it is unlikely that any fiddling with lending rules will have a major impact.

How Investors Can Take Advantage of This Situation

The fallout of APRA’s instructions are yet to take effect, but it is almost certain to affect the lending policies of banks and other deposit-taking institutions. Those lenders that are not regulated by ASIC will be less affected.

APRA has attempted to reduce funding for non-bank investment loans by extending their 30 percent cap on interest-only loans to wholesale facilities that are typically used by non-bank lenders. Consider the following APRA statement:

“A number of ADIs (Authorised Deposit-Taking Institutions) provide warehouse facilities to other lenders, allowing them to build a portfolio of loans that will eventually be securitized. APRA has been monitoring the growth in warehouse facilities provided by ADIs. APRA would be concerned if these were growing at a materially faster rate than an ADI’s own housing loan portfolio. APRA would also expect ADIs funding such warehouses to ensure that the lenders’ mortgage lending standards are consistent with industry-wide sound practices.”

The problem for APRA is that warehouse facilities are short-term and are paid out by non-bank lenders through the sale of bonds on the international money market. Any restrictions on the total amount of wholesale funding at any one time is less effective than restrictions on retail lending. There are also international players that APRA doesn’t regulate that are involved in funding to Australian non-bank lenders.

Inevitably, a reduction in the supply of interest-only loans could lead to an increase in the cost of such facilities across the board, but such increases will not be uniform. Refinancing will become frequently more attractive as individual lenders seek to rebalance their loan portfolios to meet APRA’s requirements by changing rates and/or policies. Increasingly, those lenders APRA doesn’t regulate will enjoy a competitive advantage, because they will not be forced to change.

It has always been the case that there has been a cost involved in not considering all options on their merits. In the current environment, the cost of stubbornly sticking with the same lender without regard for what else is on offer will become increasingly greater. The return on investment for those who are willing to put some time and effort into minimizing their after-tax costs will likely grow significantly.

If you would like to discuss your finance options with an expert and see if you might be able to improve your cash flow through a lower interest rate, take a moment now to express your interest at PropertyInvestingFinance.com or email me directly.

By Alistair Perry

Alistair and his brother built one of Australia’s leading providers of finance advice and brokerage services to Australian businesses and investors. After selling his stake in early 2015, Alistair took some time away from the industry to spend more time with his young family.He has now partnered with PropertyInvesting.com to provide for the unique finance needs of property investors. Property Investing Finance currently offers its own unique loan product, the Smart Finance loan, which offers one of the lowest rates in the industry. You can email Alistair or contact him at the PropertyInvesting.com office on 03 8892 3800.