September 18th, 2017
The last 12 months have seen a lot of changes and it falls on us as mortgage brokers to adapt to the new landscape. We certainly didn’t imagine that in some cases, commercial loans would end up being cheaper than residential investment loans!
APRA isn’t trying to make your life difficult
As you’re probably aware, most of the banks have made changes to their interest only policy and pricing because of limits put in place by APRA. As mortgage brokers, we naturally don’t like having our options limited, or any added complexity to choosing the right loan for a client.
However, this was the right decision for APRA to make, because:
In other words, it’s time to get behind this change and educate your clients, rather than complain about APRA!
Great questions lead to great recommendations
At Home Loan Experts weuse a few simple questions to determine if interest only repayments are suitable for a client. For example, you can ask your customers what’s more important to them:
If a lower rate or a higher borrowing power is more important to a customer, then they should probably be paying P&I.
Owner occupied loans with interest only repayments
As a general rule, this is an unsuitable option for most clients and you should only consider this if there’s a good reason to do so.
For example, at Home Loan Experts we’d consider interest only for a home loan if the client required repayment flexibility due to their business cash-flow, or if they wanted to keep their funds on standby in an offset account in case of emergencies, or if they wanted to invest their excess funds.
If they’re not financially sophisticated then it’s dangerous. They’re unlikely to benefit from interest only repayments and potentially, they may not pay off their home loan at all.
It’s time to talk to non-conforming lenders
At Home Loan Experts, we consider investment loans to be a type of non-conforming loan. That’s not to say that banks don’t do them. They’re just not the flavour of the month and you need to consider specialist lenders as well as major ones if you’re going to meet the needs of your property investor clients.
What do the numbers say?
Let’s say one of your customers is deciding between a $500,000 investment loan at 4.5% over 30 years, or a loan at 5% for 5 years with interest only payments reverting to 25 years at 4.5% with P&I repayments.
Firstly the repayments are $2,533 / month P&I compared to $2,083 / month interest only. So the payments are 21% higher if they pay P&I. At the end of the interest only period the repayments would be $2,779 which is 9% higher than the standard P&I repayments over 30 years. Few customers are aware of this and even fewer consider the effect that this will have on their cash-flow.
Paying P&I, the customer would make total payments of $912,034 whereas, with a 5 year interest only period they’d pay $958,749. That’s a whopping $46,715 in additional interest! Again few customers are aware of just how much more it will cost them.
A good rule of thumb is that a 5 year interest only period will cost a customer 11% more in interest over the term. That’s assuming, of course, that they don’t get another interest only period when their first one expires.
What about borrowing power? If a single borrower with an income of $100,000 takes out a home loan, then they can borrow around $620,000 with P&I repayments or $585,000 with a 5 year interest only period. It’s not a huge deal, only a 6% difference. For customers with multiple properties, it can have a much bigger effect.
What about your existing customers?
Should you refinance them to the cheapest interest only loan available if they’re not happy with their bank? Probably not. Variable rates can be changed at any time, so what’s to stop the new bank putting their rates up?
That means it’s time to pay P&I. Talk to these clients about either switching to a P&I loan, refinancing to another lender with P&I payments, or if they do want to pay interest only, then fixing their rate may be a good idea.
Otto is the Managing Director of Home Loan Experts and has been a member of Connective for over 10 years. Home Loan Experts has won Major Brokerage of the Year (Non-Franchise) and Otto has twice been named Australia’s Brightest Broker in The Adviser’s Broker IQ Competition.