As many as one in four homeowners are treading water on their mortgage repayments, making no attempt to repay the debt.

It is easy to see the appeal of an interest-only loan. Borrowers save money by only paying off the interest, rather than worrying about the actual principal. However, it can be a risky product.

A torrent of interest-only lending played a large part in the sub-prime mortgage boom that led up to the global financial crisis. In fact, the loans were considered so risky that British regulators were on the verge of banning them in 2012.

Australia and New Zealand have avoided a major housing crash.

But now global ratings agency Moody's is warning that Australian banks have proportionally more higher-risk property loans than they did before the financial crisis. Figures from the Australian regulator show the big four banks are going to town with interest-only loans, which make up 43 per cent of new lending.

Westpac said about a quarter of its portfolio was interest-only. A recently released Westpac product designed for investors offers an interest-only term for as long as 30 years.

Even much smaller lenders like the Co-operative Bank are getting in on the act, launching interest-only loans as of this week. Brokers report that banks almost always require 20 per cent equity, but lower repayments mean they can sometimes actually be easier to get across the line.

For regular borrowers, the product undoubtedly works in the bank's favour.

While paying off a mortgage's principal is a form of wealth creation, interest payments are essentially dead money. Falling on hard times during a trough in the market could have a borrower wind up not only with no assets, but in hock to the bank. Interest-only loans can magnify investment losses and gains alike. 

Source: Stuff.co.nz