Borrowers with interest-only loans are at a risk of being forced to sell their homes or to suffer higher mortgage repayments

The tighter lending standards by the Australian Prudential Regulatory Authority (APRA) are starting to become too real for many interest-only borrowers, who may be forced to sell their homes or suffer higher payments.

In a segment on ABC's weeknight program 7:30, University of New South Wales economist Richard Holden said there is a huge chunk of loans that are interest-only –  last year the proportion of borrowers with interest-only mortgages reached 25%.

"They're typically a five year or so period and when people have to start paying back the principal on those. That’s going to send their repayments up a lot and many people might not be able to afford them," he noted.

The rising home prices might explain the spike in demand for interest-only loans and this was seen by banks as an opportunity to lend to many aspiring homeowners.

"Banks have lent in a fairly imprudent way. They've lent too much, people have been encouraged to borrow too much partially by the market and partially by this general mania about property in Australia. That's led to a very risky situation," Holden explained.

Early last year, APRA ordered banks to reduce the volume of interest only mortgages to fewer than 30% of new loans.

Some banks admitted to having an excessive share of interest-only loans. In a parliamentary hearing in October 2017, Westpac chief executive Brian Hartzer admitted that around 50% of the bank's mortgages are interest-only. That same year, the Australian Securities and Investments Commission (ASIC)  accused the bank of breaching responsible lending provisions.

The regulations to limit interest-only loans is slowly working, as they now account for less than 25% of new loans, down from 40%. However, Holden argued that such regulations may also trigger risks.

"APRA's action could very well lead to a nice smooth diversification of the home loan books of the major lenders, on the other hand they could kind of burst this bubble of interest only loans and that the real concern is that they cause if you like a sort of a hard landing in the home loan market," he said.

Holden also noted that Australia’s lending industry is skating on thin ice, as it appears to be ignoring the consequences of the US subprime mortgage crisis.

"We might get out of it okay, everything might come to a kind of smooth landing but there's a real risk of some kind of a US-style meltdown."

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