Why you should be wary of interest only loans

Why you should be wary of interest only loans

A study by JCP Investment Partnersestimates that ‘high risk’ borrowers, such as young professionals and young families, are taking out home loans that amount to over 6 times the average household income.

As a result, the equity base of major banks could be reduced by 20%.

What does this mean?

JCP told the Financial Review that high risk, interest only loans could be ‘Australia’s sub-prime’.

In the US, sub-prime mortgages were responsible for the collapse of the housing market in 2008. In this case, US lenders provided funds to people with poor credit histories.

Because the borrower was classed as ‘high risk’, they paid higher than average interest on their loan.

As a result, borrowers in the US defaulted on loans and many lenders found it difficult to remain viable. Some even became bankrupt.

Similarly, borrowers classed as ‘high risk’ in Australia are still able to obtain high interest home loans – often in the form of ‘interest only’ loans.

The high interest associated with interest only loans makes it undoubtedly difficult for individuals to pay off. Especially since they are not ideal loan candidates to begin with.

One of JCP’s greatest concerns is what happens if people can no longer make repayments. For example, if interest rates increase, or the principal on the loan needs to be repaid.

The result is a ‘feedback loop’, where stressed mortgage holders reduce spending, and as a result, the economy is negatively impacted.

The solution

The report by JCP may sound negative, but it doesn’t necessarily have to be.

Understanding the risk associated with high interest loans empowers you to make smarter decisions when it comes to securing a mortgage.

We recommend stepping away from ‘interest-only’ loans, and speaking with a good mortgage broker, who can recommend a loan that suits your budget and goals in the long term.

Sustainability is key. If a person doesn’t have the capacity to pay off a loan with average interest, they shouldn’t be recommended a loan with even higher interest.

What if I’m not ready for a home loan?

If you’re not ready for a loan just yet, we’re often able to tell you what loan criteria you are missing.

Knowing what to work towards will help you become ‘loan ready’ in a shorter period of time.

It is so important to take on a loan that matches your needs and doesn’t cause you stress. Especially when it comes to your happiness and financial health.

Talk to our mortgage brokers

We are more than happy to talk to you about whether a home loan is right for you, and what options are available to you.

Our brokers compare hundreds of different home loan products from trusted lenders, and then pinpoint one that is right for your unique circumstances.

Contact us to get started!

Financial Advice Disclaimer:
This information is general in nature. Mortgage brokers do not provide financial advice. Clients seeking financial advice will be referred to a qualified financial planner or professional.