How to manage interest only loan expiries

Many investors will experience their interest only terms expiring over the next couple years.

Extending interest only periods will require investors to demonstrate eligibility under today’s tighter lending framework. This post aims to provide a guide on how to manage your interest only expiries and the different options investors are likely to have.

Regardless of how you choose to manage your expiry, an interest only loan expiry is a trigger to review your debts & take some form of action. What you choose to do will depend on your objectives, your eligibility & your financial position. A process map of what actions you should take is below.



Detailed Explanation

1. The first step is to work out when your interest only period expires & whether you want to extend your interest only period.

• It is advisable to start this process 3-6 months in advance.
• Interest only loans are usually preferable to investors as they offer greater flexibility to manage repayments, cash flow & tax situations. Nonetheless, they are marginally more expensive.
• In general, P&I investment loans are for relatively more balanced risk profiles. It suits investors seeking a smaller debt profile that they want to hold in the long term. Given they don’t have repayment changes over time, they are generally safer for borrowers & helps build equity over time.

2. If you do not want to extend, then your loan will simply have a higher repayment following its expiry. There are no borrowing power tests, or any documentation required by the bank here.

• In this scenario, its best to speak to your bank (or broker) and seek the best discount on your loan. Your loan is likely to default to a P&I rate higher than the market rate. Without doing anything, you’ll likely pay more than you need to. A quick phone call will likely save you thousands.
• If you decide you want a portion of your debt that’s rolling over on interest only terms OR want to pay P&I over 30 years, the process to follow is the same as wanting to extend your interest only periods in full.

3. For those who do want to extend their interest only term, the next step is to test whether you are eligible to extend your interest only period. Assuming you have enough equity in your properties, the key is borrowing power. To refinance your existing debts, you will need to show that you can afford them by having a positive monthly surplus (Income – expenses) under bank calculators. Completing this step involves testing your borrowing capacity with different lender groups. Your borrowing power tests should result into one of the three below:

• You can refinance with mainstream lenders (Major Banks, all ADI’s). In general, mainstream lenders have similar borrowing power calculators to each other & offer the cheapest residential rates/fees. Being with this lender group offers you to most flexibility to manage your debt as you have choices.

• If you ARE eligible from mainstream lenders, it is quite likely your existing lender will allow you to extend your interest only period. This will usually require new income documentation to extend your interest only period.
• Note, if you are happy to move to P&I repayments & are eligible, then you may want to seek a refinance to a 30 year loan term. This will help manage the repayment increase to P&I loan terms @ 25 years.

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• You can’t borrow from mainstream lenders, but you can borrow from non-bank lenders. Non-banks like Pepper, Liberty, Latrobe, Bluestone have more generous borrowing power calculators and hence easier eligibility criteria for renewing interest only terms.

• If you are only eligible with non-bank lenders, consider the trade-off between refinancing your debt over vs staying with your existing lender. The pros of refinancing are obtaining a new interest only period and managing your cash flow.
• The downside is that you’ll likely pay a higher interest rate & have less flexibility to manoeuvre your debt terms over time.

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• You do not pass any lenders borrowing power calculators.This effectively means you have no choice to adjust your existing debt terms and need to find other solutions. When refinancing isn’t an option, its generally a good idea to have a clear idea about what level of buffer you require to insulate yourself from this. Your options are listed below:

• Pay Principle & Interest repayments. You’re effectively forced into this arrangement rather than choosing it. It’s not all bad though, you’re likely to get a rate saving associated with paying P&I & its effectively forced savings. Given the cash flow impact, ideally, you’re in a well buffered position to mitigate your risk.

• Adjust your income/expenses to improve your borrowing power. In general, if you can get your income/expenses to the same level that you had when you first obtained the loan, you’ll likely create some refinancing options via non-bank lenders.

• Sell assets and get back to a point where refinancing is possible. If you are not eligible, work out what portfolio size you are eligible for. Selectively choose assets that you need to deleverage to get back to having refinance options.

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Additional context:


Interest only loans have dramatically fallen since the APRA restrictions in early 2017. They now account for less than 30% of all outstanding mortgages. Overall, the total amount of interest only loans in the system has now stabilised. Chart thanks to the great work from @petewargent.


This is an indication of when interest only loans are due to expire. Given the pace of acceleration in interest only debts in 2014-2015, a large portion of interest only loans are due to expire this year & next. Interest only loans generally last 5 years before expiring to principle & interest repayments.


While the repayment changes from an investors existing position may be relatively large (~$19k p.a. on a $1mill mortgage), the increase in repayment from the initial repayment is significantly smaller (~<$10k p.a.). This is because interest rates have fallen relatively significantly over the past 5 years. In addition, the majority of borrowers will have options to refinance with a non-bank. Under this circumstance, the repayment increase p.a. should be less than $5k p.a. In some cases, there’ll be little to no additional repayments depending on the borrowers existing interest rates. The above chart assumes an interest rate of 4.5% on current debt, a 5% rate for non-bank debt, a 5.50% origination rate and a 4% P&I rate.

 

nice one @Redom

pretty much

1. stay put
2. refi
3. sell down.

 

Have you witnessed any leniency by the big 4 or any of the larger FIs of late with respect to renegotiating loan terms, interest rates, extending interest only etc for situations where the borrower DID NOT PASS serviceability calcs or were marginal at best?

I know that one of the majors has a Triage backoffice unit looking at borrowers unable to cope with the IO to P&I spike - not sure what the Bank actually dishes out as far as solutions but apparently that Department's sole purpose is to look at hard cases.

 

thanks @Redom great work!

APRA's ADI figures lag hugely, but piecing together the most timely data the figure for IO loans would now be about 24pc of ADI loans o/s by value, which is easily the lowest on record.

Thus as you say the bulk of the decline on a net basis is now finished, but questions remain about the impact on consumption, mortgage arrears in WA, the borrowers still set to be switched etc.

 

Wow, given new lending stats are around that mark too, I assume there's a natural stabilisation point reached now.

Banks have been on the front foot with this for a little while now, also reporting management of this to shareholders regularly. Notifications 1 year in advance, management programs, etc. They're keen to work with borrowers who don't have options rather than force them onto something they can't actually afford (arrears/etc).

 

I get that they're sympathetic, want to work with borrowers etc etc but have you seen it first hand in terms of action plans or solutions? If so, can you cite a couple of examples (please)?

 

I've had quite a few clients with significant portfolios go through this process over the last few years. Quite likely it's not as bad as people thing.

Whilst P&I repayments are about 20%-30% more than IO repayments, the rates are usually significantly lower, at least 0.5% for most variable rates, sometimes more.

At the same time, hopefully you've been getting rental increases over the past 5 years.

Between these two factors, you can actually go a long way to making up the difference. I've seen it in the portfolios of clients with 15+ properties, I've seen it in my own portfolio.

 

pretty hard to calculate with the stock and flow so different in size, but it's getting down there for sure

 

I've had more rental decreases than increases lol. This will reverse in the next few years but for now, its dire out there.

 

I know its only anecdotal.....but our 4 in Sydney went up on average 2.9% in 2018.....so not everywhere/everyone is dire.

 

My rents have stayed the same for as long as I can remember, at least five years.

 

I've just rerented a house out in Sydney and had to drop the rent about 5% compared to 3 or 4 years ago.

 

Are non-bank lenders more lenient? I want to borrow 250k against the equity of a ppor and park it in the offset so I have liquidity over the next few years but I am told this might not be possible. But is it possible with a non-bank lender?