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Compliance tips for writing interest only loans

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Your client has a preference for interest only repayments. What do you need to do to meet your compliance obligations?

Last week, we were treated to an article by Otto Dargan from Home Loan Experts about interest only loans. If you missed it, read it here. So what are your compliance obligations? What do you need to do to ensure an interest only loan is ‘not unsuitable’ and meets your client’s needs and objectives?

Here’s an outline of the best-practice compliance procedure for interest only loans in three easy steps!

  1. Ensure interest only repayments meet the client’s needs and objectives

Review all of the client’s stated needs and objectives to ensure an interest only repayment period is suitable. You should discuss these with your client and ask some questions:

What is the purpose of interest only repayments?

Is there an economic benefit to the client?

Are there any actions required by the client to implement their strategy?

Does the requested interest only period align with the purpose of the loan?

Does it conflict with other needs or objectives?

What is the exit strategy for the loan and in what timeframe?

  1. Advise the advantages and disadvantages

In order to meet your Responsible Lending obligations under NCCP, you must ensure your client fully understands all the advantages and disadvantages of their choice of loan.

Advantages of interest only repayments include:

  • Lower repayments. During the interest only period the customer’s monthly repayments will be lower.
  • Increased cash-flow. May assist to free up cash that can be used for other purposes that may be financially beneficial. This could be to pay off higher interest rate debts, make other investments, fund the purchase of an investment property or pay the cost of educational qualifications that may increase their earning potential.
  • Maximise tax deductions. If your client wants to use their interest-only loan for property investment purposes, the interest is usually tax deductible for property investors, as long as they meet ATO rules. It should be noted, however, that owner-occupiers will not receive any tax deductions for interest if they take out an interest only loan. (We recommend that clients discuss their tax liabilities with a professional accountant or tax advisor before proceeding.)

Disadvantages of interest only repayments include:

  • The customer may not build any equity. The loan principal will not reduce during the interest only period.
  • Increased repayments at the expiry of the interest only period. You should advise your client to plan ahead for the higher principal and interest repayments that will apply at the end of the interest only period.
  • An interest only loan will cost more in interest over the life of the loan. The cost differential can be quite significant and should be clearly demonstrated to your customer.
  • Interest only loans will often have a higher interest rate than those with principal and interest repayments. The interest rate differential will partially or wholly offset the advantages of interest only loans.
  • It may be better to pay down principal while interest rates are low. Paying down as much as they can off the principal now could mean that when interest rates do rise, your customer would be paying those higher rates on a reduced loan amount.
  1. Always keep notes and client communications in Mercury.

Carefully recording all of your discussions with your clients is necessary to meet your compliance obligations. All of these discussions and a record of the client’s decisions should be documented and saved as notes in Mercury so they can be easily retrieved if required. Again, compliance best-practice is to confirm all of your discussions in an email to the client and save a copy of that too.

If you follow these 3 easy steps you will ensure you are meeting your Responsible Lending obligations under NCCP and your client is making an informed decision. You can also be sure you are recommending a loan that fully meets their needs and requirements.

Contact the Compliance Team with any questions.

If you have any questions about providing interest-only loans, the Compliance Team will be happy to help. Get in touch by clicking your help icon in Mercury or simply email us directly at compliance@connective.com.au