What to do when your interest-only mortgage expires
A record number of interest-only loans are due to expire by 2020.
The Reserve Bank estimates that, in total, $240 billion of interest-only (IO) loans is scheduled to roll over to principal and interest (P&I) in the next two years.
Worryingly, Moody's Investors Service has predicted Australian mortgage delinquencies will increase over the next two years as a result of the large number of IO loans ending and the resulting "payment shock" from the higher repayments.
If you have an interest-only loan that is due to expire soon, it will pay to start getting ready. Start by finding out exactly when the interest-only period is due to end.
"Set yourself a reminder three months before this happens to allow adequate time to review your options," says Aaron Fuda, from Omniwealth.
Fuda suggests you use the time to shop around different lenders or use a mortgage broker to determine whether your loan still fits your needs and whether you have got the most competitive rate.
When the times comes, one option will be to ask to extend your IO loan but it may be tough thanks to tighter lending criteria. If it's an owner-occupied loan, the answer will almost definitely be no but you may stand a better chance with an investment loan. You may have to submit a full application for the lender to consider.
If your current lender doesn't approve your request, you may consider approaching a new lender for an IO loan but again that will mean undergoing a credit assessment.
Do your numbers first because you may be better off paying P&I as the rate tends to be cheaper.
"The switch to principal and interest with the right negotiating on interest rate can sometimes be a more cost-effective option for borrowers," says Fuda. "Generally, the difference in the interest rate is about 0.50%."
You may also choose to refinance the loan to get an even better deal. It may also help with cash flow as "moving to a new lender and obtaining a new 30-year loan term can decrease your monthly commitment," says Fuda.
But he warns that this will also slow down the repayment of your loan. Also be aware that if your loan-to-value ratio is more than 80%, you may have to pay lenders mortgage insurance.
If you think you'll really struggle to meet the P&I repayments, have a chat to your lender. It may extend the loan period so your repayments are lower or negotiate a repayment plan, letting you pay less.
It's also a good idea to prepare for the switch by gradually increasing your repayments. For example, if your loan repayments will increase by $1300 a year, you could increase your repayment by $100 a month (four weeks) in the 13 months before, suggests MoneySmart.