RBA reveals reasons behind interest-only surge

In its Statement of Monetary Policy released Friday, the RBA said that repayment obligations, in combination with uncertainty about future labour income, are an important consideration for homeowners.

“According to liaison with banks, one consequence of this environment is that an increasing share of owner-occupiers is opting for interest-only loans to increase payment flexibility,” the RBA said.

The central bank noted that the relationship between house price growth and housing turnover, which have moved together over time, has weakened in recent years.

“The change is most evident in Sydney and Melbourne, where growth in housing prices has been strongest of late,” it said.

“The rate of turnover has remained low in those cities, both in terms of their longer-term averages and relative to growth in housing prices.”

The RBA noted an unusually low participation of owner-occupiers in recent housing market transactions.

Although interest rates are currently low, the RBA said that the expected repayment burden on loans is at 10-year average levels, when calculated using a longer-term interest rate to account for the expectation that variable interest rates will move up over time.

“Indeed, in New South Wales and Victoria, which have experienced the greatest disparity between housing prices and turnover relative to historical norms, the share of current income required to service an average loan over the next 10 years is close to historical highs,” it said.

With growth in labour income slowing, homeowners appear less willing to borrow, further fuelling demand for interest-only loans.

The RBA observed that nominal labour income has grown at an average annual rate of 2.7 per cent over the past two years, compared with a decade average of 6.2 per cent.

“The widespread expectation is that wage growth will remain subdued for a time,” it said.

“Moreover, the Westpac-Melbourne Institute survey suggests that the share of households expecting more unemployment a year ahead has been at above-average levels since late 2011, which is an unusually long time by the historical standards of the survey.”

In recent months the RBA has highlighted an increase in the use of interest-only loans, predominantly by investors, as a potential risk and a key reason for a mortgage market imbalance.

APRA’s lending guidance, released last week, states that interest-only loans may indicate that a bank is accepting a higher credit risk than for principal and interest loans.

“Any such willingness to accept higher risk would need to be reflected in the ADIs risk management framework, including its risk appetite statement” the regulator said.

“APRA expects than an ADI would only approve interest-only loans for owner-occupiers where there is sound economic basis for such an arrangement and not based on the borrowers’ inability to qualify for a loan on a principal and interest basis.”