By Duncan Hughes – 13th February 2018
Interest-only property investors seeking to switch their loan to principal and interest may be forced to sell because of lenders’ tough new serviceability requirements.
A typical borrower paying 4.5 per cent on a $400,000 loan will have to prove to their lender they can meet repayments for a 7.25 per cent loan, or an increase in annual repayments from $18,000 to more than $32,700.
The higher serviceability rates have been introduced after many investors took out their loans and are forcing borrowers to try and sell their properties, despite markets beginning to soften.
It’s worse for many self-managed super fund investors who bought investment properties and are boxed in from making bigger payments because of annual caps on the size of their contributions.
Selling may be an option, but in a falling market, as in Sydney, this may not clear the debt when it’s very high.
Selling may be an option, but in a falling market, as in Sydney, this may not clear the debt when it’s very high. Jim Rice JRZ
Real estate agents are warning the cash flow crunch is causing mortgage stress to rapidly spread from one-time mining boom towns and the outer suburbs into prestigious inner suburbs.
“Clients are ringing to say they need to refinance and their next call is that they need to sell,” said Andrew Fawell, director of Beller Property Group.
Mr Fawell, whose business covers inner Melbourne within 10 kilometres of the central business district, has been asked to value four potential mortgagee property sales in the past month after having none in the past two years.
“Many investors who bought two or three apartments with, in many cases, only 10 per cent deposit with cheap interest-only loans are beginning to feel the heat,” Mr Fawell said.
“These numbers will get a lot worse as investors find it harder to service their debt.”
The potential problem arises for many three- to five-year fixed rate loans that have reached the end of their terms and the much stricter regime introduced by the Australian Prudential Regulation Authority.
Many borrowers deposited only 10 per cent.
In recent years most major lenders have introduced a 7.25 per cent “floor for serviceability” for investor and owner-occupier loans, which is the minimum rate at which the bank will assess a home loan.
Serviceability is the lenders’ assessment of the borrowers’ capacity to afford the loan and takes into account possibly higher future interest rates. It is usually assessed by a review of income and fixed commitments over the life of the loan and potential rental income.
Richard Holden, professor of economics at University of NSW Business School, said: “This is worrying but not terribly surprising,” said Richard Holden, professor of economics at University of NSW Business School.
Professor Holden said the optimistic scenario is cashed-up buyers waiting on the sidelines to grab a bargain as the markets soften and more stock becomes available at cheaper prices.
“If there are not a lot of borrowers then we could see fire sales,” he warns, which would happen f mortgagees’ begin slashing prices amid fears that prices will nose dive.
A ‘worrying trend’
Martin North, principal of Digital Finance Analytics, said lenders were “falling over themselves to lend in 2014 and 2015”, and underwriting criteria was much more generous.
“This also means that the problem will get worse as more loans come up for periodic review, in the months and years ahead and fail current and tightening hurdles,” Mr North said.
“Those with multiple interest-only loans will be worst hit, and many of these are more affluent households. So be under no illusion, this is a significant and worrying trend which has the capacity to put many more households into financial distress. Selling may be an option, but in a falling market, as in Sydney, this may not clear the debt when very high.”
Damien Wood, principal of Spectrum Asset Management, which has about $90 million under management, said: “You can almost smell [the growing stress]. The easy money era has passed its peak. Lofty debt and valuation levels make a highly combustible cocktail for investors.”
Mr Wood compared the financing issues to the US housing meltdown a decade ago when five-year adjustable rate mortgages could not be refinanced higher after the initial “teaser” rates, leading to widespread mortgage distress.
The US situation was more extreme because the US problems were caused by low, or no, documentation loans, widespread fraud by mortgage brokers, lax regulatory oversight and flawed local securitisations, which enabled the original lender to get the debt of its books.