As read in Aust Broker online – The RBA has warned that investors with IO loans might face negative equity more quickly than P&I borrowers if house prices were to drop substantially.

RBA assistant governor Michele Bullock said on Monday that a large share of property investors has chosen IO loans because of the tax incentives, and that this could be a source of financial stress if their circumstances were to take a negative turn.

She pointed to a large proportion of IO loans that are due to expire between 2018 and 2022.

While some IO borrowers will just move to P&I terms and others may extend their interest-only period, some may not be able to meet current standards for extending IO repayments and would find shifting to P&I terms difficult to manage, Bullock said.

“This third group might find themselves in some financial stress. While we think this is a relatively small proportion of borrowers, it will be an area to watch.”

Speaking at an event in Sydney, Bullock said that though investors tend to have lower starting LVRs and often have other assets as well as earn rental income, they have less incentive than owner-occupiers to repay their loans.

“Indeed, the macro-financial risks are potentially heightened with investor lending,” she said.

Illustrating how investor lending could increase such risks, Bullock said investors might be more inclined to sell investment properties when house values drop to minimise capital losses, which might exacerbate the price fall.

“As investors purchase more new dwellings than owner-occupiers, they might also exacerbate the housing construction cycle, making it prone to periods of oversupply and having a knock on effect to developers,” she said.

Growths in investment and IO loans have slowed as APRA clamps down on higher risk lending.

RBA data released on 31 January shows that investor home lending grew 6.1% (seasonally adjusted) in the 12 months to December 2017 – down from 6.2% from a year ago.

Banks have also recorded slowdowns in their investment and IO lending businesses. CBA reported earlier this month that its home loan growth moderated to 5.2% in the 12 months to December 2017, dragged down by the sluggish increase in investment home loans.

The bank’s investor home loans increased by 0.5%, while owner-occupied loans grew 7.5%. IO lending comprised 21% of total flows at the end of December 2017, down from 38% six months ago.

There is no end in sight to investment and IO lending’s troubles now that APRA is zeroing in on investment and IO loans in its latest proposals targeting higher-risk residential mortgage lending.

Under APRA’s proposal, standard eligible mortgage portfolios will be categorised into lower-risk and higher-risk exposures – besides being assigned risk weights according to LVR.

IO and property investment loans and loans to SMEs secured by residential property will fall under the higher-risk category, while the lower-risk class will include owner-occupied P&I loans and would apply after consideration of lenders mortgage insurance.

John can be contacted on 0749722081 or 0410433919. Or email him at jwhitten@ihl.net.au or net www.ihl.net.au. John Whitten is a credit representative (CRN 399796) of BLASSA Pty Ltd (Australian Credit Licence No 391237).