UBS warns of widespread interest-only mortgage defaults in the next few years

Investors in bank shares should be alarmed by a shocking warning from a leading broker that 1-in-5 mortgagees on an interest-only (IO) loan is at risk of defaulting over the next few years.

UBS says the stress will come when IO loans mature and revert to principle and interest (P&I) loans when repayments jump, according to a report in the Australian Financial Review.

It is estimated that there are 1.5 million borrowers on IO loans worth nearly $500 billion which will convert to P&I loans over the next four years.

According to ASIC’s mortgage calculator, borrowers on an IO loan of $300,000 at 4% interest is likely to see their monthly repayments jump from around $1,000 to circa $1,700 (the longer your IO loan is for, the greater the increase when it converts to P&I).

In case you missed it, that’s a 70% increase in mortgage repayments and that’s not factoring in an increase in interest rates.

This probably explains why UBS believes 18% of respondents to its 2018 mortgage survey won’t be able to meet their monthly repayments when their IO loan rolls over. That equates to around 270,000 defaults just on IO loans.

Throw in higher interest rates and falling property prices, and this default estimate might prove to be somewhat conservative. We’ve already seen almost all banks, including our two biggest mortgage lenders Commonwealth Bank of Australia (ASX: CBA) and Westpac Banking Corp (ASX: WBC), lift rates independent of the Reserve Bank of Australia.

It’s also noteworthy that the big banks have been reducing their bad debt provisioning to boost profit growth in the past few reporting seasons. I will be keenly watching to see whether this trend reverses in the November profit season when Westpac, Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank Ltd. (ASX: NAB) releases results.

One factor that could be compounding the IO loan issue is the general lack of understanding of the product. UBS was alarmed to find that a third of IO borrowers who are owner-occupiers had opted for the loan to benefit from negative gearing. Negative gearing is only available to investors.

Further, around 14% of these borrowers are house flippers. They plan to sell their homes at a profit before their IO loan expires. They probably missed the boat on this one.

While investors cannot afford to ignore this risk, banks may be able to manage the risk by extending IO loans. They are already curbing new IO loans and that could give them some flexibility to roll over these loans into another IO term loan over the next few years.

It’s kicking the can down the road – but that’s what central banks did during the GFC to get us out of the last mess.

Let’s just hope our chickens are on a long walk before they come home to roost.

Top 3 ASX Blue Chips To Buy In 2018

For many, blue chip stocks mean stability, profitability and regular dividends, often fully franked..

But knowing which blue chips to buy, and when, can be fraught with danger.

The Motley Fool’s in-house analyst team has poured over thousands of hours worth of proprietary research to bring you the names of "The Motley Fool’s Top 3 Blue Chip Stocks for 2018."

Each one pays a fully franked dividend. Each one has not only grown its profits, but has also grown its dividend. One increased it by a whopping 33%, while another trades on a grossed up (fully franked) dividend yield of almost 7%.

The names of these Top 3 ASX Blue Chips are included in this specially prepared free report. But you will have to hurry. Depending on demand – and how quickly the share prices of these companies moves – we may be forced to remove this report.

Click here to claim your free report.

Motley Fool contributor Brendon Lau owns shares of Australia & New Zealand Banking Group Limited, National Australia Bank Limited, and Westpac Banking. 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 Scott Phillips.

The 5 mining stocks we’re recommending in 2019…

For decades, Australian mining companies have minted money for individual investors like you and me. But if you believe the pundits and talking heads on TV, those days are long gone. Finito! Behind us forever…

We say nothing could be further from the truth. To earn the really massive returns, you’ve got to fish where others aren’t fishing—and the mining sector could be primed for a resurgence. That’s why top Motley Fool analysts just revealed their exciting new research on 5 ASX miners they believe could help you profit in 2019 and beyond…


The best way we see to play the global zinc shortage… Our #1 favourite large-cap miner (hint: it’s not BHP)… one early-stage gold miner we think could hit the motherlode… Plus two more surprising companies you probably haven’t heard of yet!

For free access to our brand-new research, simply click here or the link below. But be warned, this research is available free for a limited time only, and we reserve the right to withdraw it at any time.

Click here for your FREE report!