The Westpac Banking Corp (ASX: WBC) share price rose 0.5% to $30.27 today after Fairfax media reported that the company was hurriedly trying to convert its interest-only borrowers onto principle + interest (P+I) loans.
Approximately 50% of all Westpac’s loans are interest-only, as the company has been a big player in the booming property investment market in recent years. Now however, bank regulator APRA has limited future interest only loans to 30% of the housing market in the future.
This means that as interest-only loan terms (typically 5 to 7 years) reach their end date, many borrowers will be forced to switch to principle + interest loans, which have higher repayments.
Big banks including Commonwealth Bank of Australia (ASX: CBA) and National Australia Bank Ltd. (ASX: NAB) have recently announced higher rates on interest-only loans in order to encourage borrowers to convert to principle + interest repayments, and help the banks meet their APRA target.
Additionally, policies for lending to SMSFs and via mortgage brokers are also reportedly being tightened. The net effect is that it will be harder and likely more expensive to get a loan.
Total borrower weekly repayments could rise – despite the lower interest rates on P+I loans – because principle and interest repayments are higher. Some rudimentary calculations suggest that there is up to a 40% jump in repayment requirements when one switches from interest only to principle + interest loan- from $1458 to $2046 a month (assuming 350k loan, flat 5% interest rate, 25 year loan term).
This is a big concern for Westpac with so many interest-only loans. The bank may have to accept lower interest rates or offer other enticements to borrowers to convince them to switch over.
There is a lot of commentary about whether we are or are not heading for a housing crash. I don’t know the answer to that, but with so much of Westpac invested in interest-only loans, and so many borrowers effectively facing higher repayments, I am avoiding its shares today.
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Motley Fool contributor Sean O'Neill has no position in any stocks mentioned. The Motley Fool Australia owns shares of National Australia Bank Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.