Why is there a rate disparity between interest-only and principal interest rates?

“He goes … ‘It's going to be about $200-difference to go principal-and-interest you're going to be paying down an interest component of it. No worries at 90 per cent,’ ” he added.

The reason behind the disparity

James explained that the gap between interest-only rates and principal interest rates are largely due to the APRA changes in lending regulations. In 2015, the government agency thought there were too many investors in the market, so they decided to slow down the influx by putting a “10 per cent cap”.

“Banks can't grow their investor lending by more the 10 per cent on annualised basis. That was sort of met, the market came down a little bit, RBA did two rate cuts, and the market resurged,” the mortgage expert said.

Following the resurgence of the market, APRA then decided to make adjustments to regulations on interest-only loans, saying that there cannot be more than 30 per cent interest-only loans in all new lending records—”for every hundred mortgages you write, only 30 of those can be interest-only”.

In order to achieve this, banks used the pricing lever. They put up the rates for interest-only loans by around 30 basis points and reduced the rates of principal-and-interest loans by around five to ten basis points.

According to James: “They also cut any sort of fees or anything like that to switch over, and they came up with some really competitive fixed rates of P&I as well.”

Politics and the central bank

A lot of investors have been doing well in the market because the prices have been kept low by the central bank, but that is an intervention, according to Momentum Media’s Aleks Vickovich. Based on the basic market dynamics, the Australian property market should not be performing the way it is doing now, but the government intervened.

Aleks said: “This whole conversation if it shows one thing, it's the amount of power that governments have over the market … It's so important to pay attention to this stuff because they can come in and completely change the dynamics just with one piece of law.”

Looking on the bright side, Australian investors may consider themselves fortunate because both the government and the central bank have been proactive in trying to keep the price growth at a reasonable and sustainable level. However, political biases that may affect certain decisions cannot be overlooked in this conversation. Some people believe that they should “let the market be the market”.

“I think there's a few problems. One is that I think, very often there's a political reason why the central bank does what it does ... Central bank takes its orders from [the] government in the same way that APRA does … [but with] some independence, of course,” Aleks explained.

At the end of the day, while the movements of the market are affected by several dynamics such as demand-and-supply and economy, it could still be well-dictated by election cycles. 

Tune in to Aleks Vickovich and James Mitchell’s episode on The Smart Property Investment Show to know more about politics, power poverty, rebalancing mortgage books and interest rates, as well as the recent policies by major banks hurting the property market, current monetary policies, and the reasons why there is a disparity in rates.

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