Over the past few months, the major banks have made some significant changes to interest rates (some of which take affect this week). The government has directed the banks to dramatically reduce the volume of existing and new interest only home loans and investment loans (see here for more on this). What the banks have been doing is increasing interest rates on any interest only loans in order to incentivise borrowers to switch to principal and interest (herein “P&I”) loans. They have reduced interest rates by a tiny margin on P&I home loans.
The margin is now over 1%
The interest rate differential between a P&I home loan (circa 4.20%) and an interest only investment loan (circa 5.25%-5.30%) is over 1.00%! In December 2015 (approximately 18 months ago), the interest rates for these two different loan types were identical.
Interest only loans are now more expensive and the banks don’t want this business.
What can you do about it?
There are three possible solutions. Which solution best suits your needs depends on your individual circumstances and future plans (don’t forget the important theme of this blog). Of course, we’re here to help so feel free to contact us if you would like help working out which solution is best for you.
(A) Switch to a fixed rate
Variable interest only (herein “IO”) investment loan rates are currently in the range of 5.05% and 5.30% p.a. (but depend on your discount). Many of the current IO fixed rates are a lot lower – here’s an indication of current fixed rates (investment & IO):
2 years = 4.20-4.50%
3 years = 4.30-4.50%
4 years = 4.50-4.90%
5 years = 4.50-5.00%
However, before you fix your interest rate, read the first half of this blog for some of the things you need to consider.
(B) Switch your repayments to P&I
The difference between P&I and IO investment variable rates is currently circa 0.45-0.50% p.a. Don’t forget that you receive a tax deduction for investment loans so the after-tax differential is lower – maybe between 0.24% and 0.30% p.a.
If you have surplus cash flow and the higher P&I repayments don’t worry you, then switching to P&I might be a good way to mitigate the impact of these rate hikes. We usually don’t like to make P&I repayments on investment debt but in some limited circumstances it’s okay.
Alternatively, if you have some equity in your property/s, there might be an alternative loan structure that will allow you to obtain the lower P&I rate whilst still only paying IO.
(C) Refinance to a lender that is not an ADI
An ADI is an Authorised Deposit-taking Institution (a bank). ADI’s are regulated by APRA. APRA is the regulator responsible for setting the interest only and investment loan volume restrictions mentioned above. Some lenders are not ADI’s and therefore escape these APRA directives. These lenders are often referred to as mortgage managers. Mortgage managers borrow money at wholesale interest rates (and/or by issuing mortgage-backed securities) and on-lend it to consumers. They are still safe to use and are regulated by ASIC.
The interest rates offered by some mortgage managers are now approximately 1% lower than the major banks (for interest only investment loans).
Planning to make a change? It’s our job to guide you
The above blog is a summary only and there is a lot more to consider when contemplating any of the changes above. Therefore, to ensure you are making a fully informed decision (that you won’t regret in the future), please don’t hesitate to reach out to us. We can have a quick chat with you and share what we think is the best course of action. In fact, it is quite possible that “doing nothing” is the most intelligent thing for you to do.
