Payment Shock: When your repayments change to principle and interest

At a given point in time, the economic and financial market conditions tend to elevate particular risks above others.

While this changes over time, we thought it would be useful to explore one of the current ‘heightened’ risk in 2018 – changing repayment terms.

Recent regulatory changes to the lending market have made it harder for borrowing to pass servicing on interest only terms, and have also increased scrutiny on borrowers who want to extend existing interest only terms.

When interest only terms expire you will likely need a full reassessment of your situation before they can be extended. Where you are no longer able to pass servicing (which is now a harder bar that when you originally got the loan), your repayments will revert to principle and interest.  While your income and buffers may be able to handle a few of your investments doing this, you’ll find the larger your portfolio the harder this becomes to manage.

This, coupled with a change in interest rates over time, could lead to ‘payment shock’. As a general guide, the impact of moving to interest only to P/I equivalent to about a 2% interest rate rise, or a 40%+ rise in your monthly repayment bill. Combine both a couple interest rate rises (prudent) and the need for your principle payments, and you have the makings of a cash flow nightmare. By and large, this will impact property investors who have large portfolios and debt sizes the most.  The amount of income you earn will determine what level of debt is healthy and whether or not a move to principle and interest could force you to deleverage.