The housing boom continues to generate headlines with a range of ideas continually being bandied about. Banning interest-only loans is the current hot favourite, with the financial services regulator putting pressure on lenders to slash the number of interest-only loans being approved.
The thinking seems to be that interest-only loans are extremely risky, as well as costing more than a normal principal and interest loan.
These are half-truths. Certainly, you can reduce demand for real estate by forcing investors into P&I loans, because the repayments are much higher, but you make the situation much riskier for the borrowers as their monthly commitments will be dramatically increased.
At an interest rate of 5 per cent, the repayments on an interest-only loan of $300,000 would be $1250 a month - on a 10-year P&I loan they would be $3182 a month. To make matters worse, the bank would jack up their interest rate if they fell into arrears.
But, judging by the emails I am receiving, banks are attempting to convert existing customers away from interest only.
The following is typical: "We have an investment loan, which has been interest-only for 10 years. During that time the property has doubled in value, which means the security to the bank is much greater. We have never missed a payment. The bank now wants us to change the loan to a 10 year P&I loan. We could not afford the payments on a P&I loan over 10 years and may be forced to sell the property and incur a large capital gains tax bill. What are our options?"
Think about the ramifications of this. These people have been good customers of the bank for over 10 years, which one would think would have been a win-win situation for both parties. The customers now have their retirement plans on track, and are using surplus funds to build their superannuation so that part of it could be withdrawn to pay off the investment loan when they retire.
At retirement, they could live off the rents from the now debt-free property, as well as drawing down on their super. They have fulfilled the Australian dream - a prosperous retirement with no need to put their hand out for welfare.
But the actions of their bank, no doubt fuelled by the Australian Prudential Regulation Authority's aim of cracking down on a housing boom that is happening only in Sydney and Melbourne, has put those plans at risk. If they have to sell, not only do they face a capital gains tax bill, which will take a big chunk of their retirement capital, they would also lose any capital gain the property may give them in the next 10 years.
So what are their options? Provided they have reached their preservation age, they could take advice about starting a transition to retirement pension (TTR). This would enable them to draw an income from their super, which would give them sufficient extra income to handle the increased mortgage payments. The downside of this strategy would be that the TTR payments would be fully taxable, less a 15 per cent rebate, and their superannuation balance would be less when they retired that would have been if they have not been forced to draw on it.
A better option would be to change banks. My mortgage broker friend tells me other banks would welcome the business, and then there would be no need to dispose of the property, or run down the superannuation using a TTR.
But isn't this all a waste of everybody's time? We now have a crazy situation where the banks are spending huge dollars on full page advertisements telling us that they have changed their attitude and are now committed to helping their customers prosper. There are billboards outside most bank branches inviting customers to apply for loans. Yet the very banks who are advertising for business are chasing away the good customers they already have, while showing no interest in helping them attain their financial goals.
It's a fundamental business principle that it is cheaper to keep a good customer than to find a new one. It seems that the banks have forgotten this. Luckily, there are good mortgage brokers who can help them find a suitable new loan - and once they have an offer in hand they can speak to their current bank's retentions team, who sometimes have excellent offers to keep their custom after all. It's a strange world.
Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. His advice is general in nature and readers should seek their own professional advice before making any financial decisions. Email: email@example.com