We of the never-never home loans

THE RESERVE Bank is alarmed at the rise of interest-only home loans, warning of negative equity for borrowers who fail to make inroads into the principal of their loans while house prices fall.

Sydneysiders who bought at the peak of the property boom and have faced the sharpest falls in property values are most at risk of negative equity, where the size of the debt exceeds the value of the home.

Despite not having to make principal repayments, borrowers with interest-only loans were found to be twice as likely to fall behind on their payments. "The [nationally] higher arrears rate is hardly surprising, given the general lowering of credit standards that has occurred since the mid-1990s," the Reserve Bank said.

Fierce competition among banks for market share has led to an increase in interest-only loans being offered to people who previously may not have been considered creditworthy. A third of sub-prime borrowers - those who do not meet standard income or credit history requirements - choose interest-only payments.

But by lowering upfront repayments, these loans encourage already at-risk borrowers to take on more debt, the Reserve says.

Its review also found evidence that mortgage arrears are on the rise. NSW suffered the largest increase in loan arrears over the past year, consistent with other signs of stress, including a doubling in repossessions.

We of the never-never home loans