Earlier this month, Rabobank said it is limiting the percentage of new home loans that can be taken out as interest-only – or, to use the Dutch term, aflossingsvrij, meaning no repayments of the principal loan.
You may never have heard of interest-only mortgages in the Netherlands because they are largely out of favour with banks, as Rabobank’s decision illustrates. But they do still exist, so I thought it would be useful to look at how interest-only mortgages work and why they can still be a good idea in some cases.
Rabobank said in January it will cap the interest-only portion of new mortgages at 30%, down from the current 50%, with an absolute maximum of €150,000 from mid-May. If you do the sums, you will see that the maximum property value eligible for an interest-only component will be €500,000.
Large debts
The bank said it was prompted to make the move following warnings that interest-only mortgages may pose a risk to both homeowners and banks themselves. The central bank and financial services regulator AFM have both argued that borrowers could be left with large debts at the end of their mortgage term because the capital has not been repaid.
So far, Rabobank is the only major Dutch mortgage provider to make this change. But the decision, and the position of market regulators, raises a number of broader issues.
In 2013, the government decided that only linear and annuity-based mortgages – both of which involve repaying the loan capital – would be eligible for mortgage tax relief. The maximum period for claiming mortgage interest tax relief had already been limited to 30 years in 2001.
Cut your tax bill
As a result, first-time buyers can no longer opt for an interest-only mortgage – if they want to reduce their income tax bill that is. But of course, that does not mean such mortgages are unavailable.
I work with three groups of people who still make use of them: clients working for international organisations who are tax-exempt; people who already had an interest-only mortgage before the law changed in 2013, and people facing high asset tax bills in Box 3. This is because an interest-only mortgage can be deducted from your taxable assets, reducing your tax bill.
For example, if you have assets worth €200,000 and an interest-only mortgage of €150,000, you only pay asset tax on the difference. In that sense, interest-only mortgages can be a useful tool for people with assets who want to limit their tax exposure.
Repaying the loan
Banks regularly ask clients how they plan to repay the debt when the mortgage expires, and this is something borrowers should should be aware of, of course. Some may expect an inheritance, or plan to downsize or sell their home when the mortgage term ends. There are many ways to repay a mortgage other than through monthly repayments!
An interest-only mortgage is not suitable for everyone, and it is always advisable to discuss the options with a financial advisor who understands your own situation. But just because banks and regulators are wary of them does not automatically mean an interest-only mortgage is the wrong choice for you personally.
