No justification for interest-only mortgages
Seriously, what is the reason behind the interest-only mortgage? I'd like a banker to look me in the eye and attempt to answer that with a straight face.
At the risk of stating the obvious, their purpose seems to be to encourage investors into the housing market and expand banks' profits, with no regard to the knock-on explosion in house prices.
They should be more accurately called the Hippopotamus-mortgage.
Harmless and slow-moving in appearance, but one of the most dangerous animals in the world. With teeth the size of milk bottles, a two-tonne weight and running at 30km per hour these beasts can get out of control.
The irony is that a group of Hippos is called a "bloat". The exact effect the interest-only mortgage has on the housing market.
Of course many factors bloat the housing market and the main culprit in New Zealand is lack of supply. When investors find an asset with a long-term embedded supply problem, they are guaranteed to be on a winning streak. The structural issues in this asset class have wiped away years of negative equity risk.
They've ridden on the back of this capital-gains Hippo for too long.
Interest-only deals may "expire" in theory, but are often re-issued for a consecutive term by banks that have benefited from the house price bloat.
Once their customer has snaffled some free equity from a tight market, the risk of the mortgage gets less. The house will easily sell for more than the original loan. It's perverse that price-bloating lessens the risk for the designers of the hippo-mortgage. There's no natural hand-brake on the product.
I'll admit it, I was once a banker. But back then an interest-only mortgage was something you whispered about. Of course they existed and I'm pretty sure I had one for a year or two. It was 20 years ago and we were getting married and moving overseas. A bit of short-term relief helped fund it all. I recall getting a very stern lecture about the perils from the credit department. Mind you with double-digit interest rates the sombre chat was warranted.
There are some perfectly valid reasons for a home-owner asking for an interest-only solution. Mostly these surround lowering expenses for a short period due a change in circumstances – a home renovation, starting a family, losing a job or a drop in income. Repayment holidays are also possible when things get tough.
What valid reason entitles someone to an interest-only mortgage? Especially in a climate of dire housing affordability. If you don't live in the house, interest-only should be banned. If you want to rollover an interest-only mortgage, you should be declined. Sell some houses and realign your portfolio with what you can actually afford.
If you're a homeowner who can't afford a repayment mortgage on day one, come back when you can. If you're a commercial developer creating new housing supply that's different; approved.
Would a ban on interest-only really make a difference to the housing market? You bet your socks it would. There are $213 billion in mortgages in New Zealand and 28 per cent of these are interest-only ($60 billion). The Reserve Bank just started monitoring the "trend". Err bit late. Scary numbers are coming out. In May 38 per cent of mortgages were interest-only. In June 41 per cent. That's a mighty big lever we've got to play with.
Westpac just announced a reduction in the length of their interest-only product from a 15-year term to five years. Back in 2014 they had a 30-year product. A few banks already have five-year limits and some 10 years.
The first Hippo in the room is why do you even need a five-year period of paying interest-only? The second Hippo is what stops the banks with a five-year term rolling over into another? The time limit is just a checkpoint on their risk exposure. So announcements on reduced terms are just well-intended bluster.
Is it any surprise my banking career was short lived? My boss at the time was Grant Spencer (currently deputy governor of the Reserve Bank). We both worked in a dark rat-hole called Treasury. This is a man who understands the markets very well, from both the point of view of a bank and the Reserve Bank. Now he's no longer on the dark-side he might be able to grab the leaver and switch it to off mode.
Janine Starks is a financial commentator with expertise in banking, personal finance and funds management. Opinions in this column represent her personal views. They are general in nature and are not a recommendation, opinion or guidance to any individuals in relation to acquiring or disposing of a financial product. Readers should not rely on these opinions and should always seek specific independent financial advice appropriate to their own individual circumstances.