Fears of housing 'fire sale' as interest-only loans roll into principal plus interest
As property prices in Australia have climbed over the past few years, thousands of Australians desperate to get a foothold on the property ladder have used interest-only loans.
But the interest-only period on these loans doesn't last forever.
Over the next three years, interest-only loans worth a combined total of about $360 billion will roll over to interest plus principal — and that means borrowers will face higher repayments.
"The kind of nightmare scenario is where a lot of people need to sell at once, and that's when you see a kind of fire sale mentality, and could see very significant downward pressure on prices," said Professor Richard Holden from the University of New South Wales Business School.
"That puts the banks under stress, and their balance sheets under stress, and it could lead to significant financial instability."
Six months ago Professor Holden said there was a risk the Australian housing market could face a US-style meltdown, and he maintains there is a risk that downward pressure on prices could lead to financial instability.
According to ABS data released on Tuesday, residential property prices fell 0.7 per cent in the March quarter.
Sydney recorded an annual price fall of 0.5 per cent, the first since the March quarter of 2012.
Prices in Melbourne dropped 0.6 per cent, the first quarterly fall since the September quarter of 2012.
'Worst decision I've made in my life'
For Queensland farm manager Hugh Mackey, 61, the switch to interest-plus-principal repayments may prove too much.
He and his wife tried to build a retirement nest egg, buying two investment properties in the coal mining town of Blackwater in 2008, financed by almost half a million dollars in interest-only loans with ANZ.
"I'm not sure I can retire at 65 the way things are going now," he said.
The town's rental market has slumped, the houses have halved in value, and Mr Mackey is struggling to meet his loan repayments.
"At the moment, with interest only, we're forking out I think approximately $30,000 a year of our own money, separate to the rental income, to not default on the loans."
Mr Mackey has never missed a payment so far, but this month his loans are switching over to principal-plus-interest.
That means he'll have to find another $12,000 every year to cover the mortgages.
He is yet to speak to his bank.
"If it gets serious and ugly, I presume they can probably bankrupt me," he said.
"I don't want that to happen, but I can't see an easy solution, and in the meantime I want to keep trying to pay the repayments."
Even if he sells both investment properties, he has zero equity and may still owe ANZ about $250,000.
He says he regrets ever buying the Blackwater houses.
"It was probably the worst decision I've ever made in my life," he says.
'A big strain for a lot of people'
The Reserve Bank of Australia estimates that a total of $360 billion worth of interest-only loans will roll over to principal-plus-interest in the next three years — for the average borrower that means about $7,000 a year in extra repayments.
Professor Holden says that will prove a stretch for many.
"That's a big strain for a lot of people, and in terms of cashflow that's very hard for a lot of people to meet, particularly if they're overstretched," he said.
At the same time it has become harder to refinance, with banks applying greater scrutiny to people's debts and spending habits.
By 2015, interest-only loans had grown to almost 40 per cent of outstanding housing credit in Australia.
In March 2017, the Australian Prudential Regulation Authority put the brakes on, limiting interest-only lending by the banks to 30 per cent of new home loans.
Earlier this month, official data showed new lending to property investors had fallen to its lowest level in two years.
But Australia is still exposed with these types of loans when compared to overseas markets.
In the UK, 17.6 per cent of home loans are interest only.
In the US, where interest-only loans played a role in the global financial crisis, lenders there have only recently started offering these types of loans again, but with extra safeguards.
'We've planned for this'
Heather Shaw and her husband Dave decided on an interest-only loan with ANZ when they bought their five-acre property outside Perth five years ago.
It has meant they have been able to afford a much-needed new roof for their house and fencing for their property, while Ms Shaw was able to take time off from her job when her children were young.
"We decided to take interest only so I can take a full 12 months off work without having any sort of financial strain on us," she said.
Their home loan will roll over to principal plus interest later this year, and their $1,900 monthly repayments will increase by about a quarter.
"This is a strategic move for us, we've planned for this," she said.
Ms Shaw is returning to work, and she and her husband are already making extra repayments on their loan.