25556 Chap.7 Bank Lending and Loan Repayments
Bank Lending and Loan Repayments
The second half of Topic 3 looks at what banks do with the money they raise. A slice of assets is kept in cash and liquid securities, but most is lent, and housing loans dominate.
The chapter sets out the mix of owner-occupier and investment loans, the difference between reducible and interest-only structures, and why investors accept a loan that never shrinks, including the role of negative gearing.
It then covers the standards APRA expects lenders to apply: servicing tests at a higher rate, verified income, mortgage security, loan-to-value limits and stress testing, along with signs of loan quality such as the share of non-performing loans.
Annuity arithmetic links all of this, giving the repayment on a loan, the amount a repayment can support and the balance still owing. The chapter ends with household and business loan structures and with securitisation, which lets a bank sell a bundle of home loans to investors.
What this chapter covers
- 01
Liquid securities and why banks hold them
- 02
Owner-occupier, investment and interest-only housing loans
- 03
Annuity repayments and balances still owing
- 04
Prudent lending standards and loan-to-value ratios
- 05
Household and business loan structures
- 06
Securitisation through special purpose vehicles
Worked example · free
Split ten years of payments into interest and principal on interest-only and principal-and-interest versions of a $640,000 loan
- 1First payment: interest is 640,000 × 0.005 = $3,200, so only 3,837.12 − 3,200 = $637.12 of it reduces the principal.
- 1Interest-only over 120 months: cash paid 3,200 × 120 = $384,000, all of it interest; principal repaid $0, so $640,000 is still owed.
- 1Principal-and-interest over 120 months: cash paid 3,837.12 × 120 = $460,454.40; principal repaid 640,000 − 535,588.17 = $104,411.83; interest is the rest, 460,454.40 − 104,411.83 = $356,042.57.
- 1Comparison: the principal-and-interest version costs $76,454.40 more cash over ten years, yet pays $27,957.43 less interest, because each payment shrinks the balance that interest is charged on.
Key terms
- Reducible loan
- A loan whose regular payments cover interest and part of the principal, so the balance falls to zero over the term.
- Interest-only loan
- Borrowing on which each payment meets only the interest due, so the amount borrowed never falls.
- Loan-to-value ratio
- The loan amount divided by the value of the property securing it.
- Negative gearing
- Offsetting a loss on an investment property, where costs including interest exceed rent, against other income.
- Revolving credit facility
- A business borrowing arrangement that lets the borrower draw and repay funds as its needs change.
- Non-performing loan
- A loan on which the borrower is 90 days or more behind in payments.
Bank Lending and Loan Repayments FAQ
How do you calculate the repayment on a housing loan?
Treat the repayments as an annuity. Divide the loan amount by the present value annuity factor, which is one minus one plus the periodic rate raised to minus the number of payments, all divided by the periodic rate. For monthly repayments use the annual rate divided by twelve and the term in years times twelve.
How do you find the amount still owing on a loan?
The balance owing at any date is the present value of the payments that remain. Multiply the regular repayment by the annuity factor for the number of payments left, using the same periodic rate. This avoids tracking every payment and works for any point in the loan's term.
Why do investors choose interest-only loans?
Payments are lower because no principal is repaid, which improves cash flow while the property earns rent. The investor's return comes from net rental income and any capital gain, and they may plan to refinance or sell the property to repay the loan. Rental losses can be offset against other income through negative gearing.
What lending standards does APRA expect for home loans?
Lenders should test whether the borrower can service the loan using a rate above the current one, verify income and living expenses, take security over the property, take care with loans arranged by brokers, price for cost and risk, plan for distressed loans and stress-test their loan books. Mortgage insurance applies when the loan-to-value ratio is above 80%.
How are large business loans priced?
Each is negotiated individually. The interest rate is a reference rate that covers the bank's funding and other costs, plus a margin that reflects the borrower's credit risk. Security comes from covenants and mortgages, and the loan may be a term loan of up to ten years or a revolving facility drawn as required.
Exam move
Write the annuity factor once in full and use the same layout for every loan question: periodic rate, number of payments, factor, then repayment or loan amount. Practise all three directions on loans you invent: the repayment for a given loan, the loan a given repayment supports, and the balance after a stated number of years from the payments still to come.
Check each answer by asking whether it makes sense, for example that a balance after ten years of a thirty-year loan is still well above half the original amount. For the descriptive side, list APRA's lending standards and the business loan structures as short cards and test yourself with scenarios.
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