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Danger looms for interest-only property investors

The Australian property market has been one of the best asset classes over the past five years.

However, questions are now being asked about how healthy that rise was. According to research done by Morgan Stanley, Westpac Banking Corp (ASX: WBC) has the highest amount of investor interest-only loans at 21% of loans. National Australia Bank Ltd (ASX: NAB) is next at 24%, Commonwealth Bank of Australia (ASX: CBA) at 21% and finally Australia and New Zealand Banking Group (ASX: ANZ) at 17%.

Australian mortgages represent about 30% of cash earnings for the banks, which is a huge part of their earnings.

The problem is that a lot of these interest-only loans will reset to interest and repayment terms. The figure is estimated at $60 billion over the next four years.

Repayments could increase by 40% to 50% unless borrowers are able to refinance to another interest-only loan. However, new lending rules are stricter than they were four years ago. Interest-only borrowers are some of the most indebted property owners and are unlikely to have the capability of refinancing.

Some property owners may be able to afford the higher repayments of capital, but will have to reduce their discretionary spending. The Australian household savings rate has reached the lowest for a very long time, leaving little wriggle room. Reduced spending could harm the economy.

Another option for the indebted property owner could be to sell the property and move on. However, with house prices already falling across Australia a surge of property sales could see house prices fall pretty steeply.

People will do almost anything to avoid selling their property, so it could be the retail sector that suffers first. Watch out for JB Hi-Fi Limited (ASX: JBH), Harvey Norman Holdings Limited (ASX: HVN) and Nick Scali Limited (ASX: NCK) reporting lower sales.

I don’t think 2018 will be the year where the big banks start reporting rising bad debts, but 2019 could be the start of an economic dip if things don’t go the right way.

I’d much rather invest in these shares to avoid any property crisis.

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Motley Fool contributor Tristan Harrison has no position in any of the 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.

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