Banks are seeking to cover rising funding costs from paying generous deposit rates to local savers coupled with higher overseas' funding costs.

"There is a real battle going on for deposits," said Martin North, principal of Digital Finance Analytics, which advises banks and financial service companies.

Under Westpac's changes, interest-only repayments will face a 'rate loading' of 0.04 per cent.

Mortgage brokers, which are key distributors of the bank's products, say they are being told the higher rates are for borrowers' benefit.

"We have changed how we price interest-only home loans compared to principal and interest home loans," Westpac explained in a confidential briefing note to brokers.

"As a result, we will now offer lower interest rates to customers who make principal and interest repayments to encourage them to pay down their debt and own their home sooner," the bank added in the note.

Some mortgage brokers, who did not wish to be named, are claiming that the bank has an "interesting perspective on its customers' priorities".

Other banks are likely to follow the move following a resurgence in demand for investment loans due to higher-than-expected capital growth.


"Banks are doing more investment loan lending than they expected and investors are more likely to go for interest-only loans," Mr North said.

"Regulators are worried about this (because of repayment problems if there is a sharp rate increase), banks are able to lift their rates and still maintain sufficient volumes while remaining within regulatory guidelines," he said.

In a separate move, the bank is cutting discounts on its home loan packages for house buyers and investors, which could result in a worse deal for customers if they do not check the small print and switch loans at the end of the fixed term.

A Westpac spokesman said: "From time to time we offer special discounted rates to our customers, and we've launched a highly competitive introductory rate (for new customers) of 3.75% p.a. for the first three years for our Flexi First Option Home Loan. This has replaced our previous two year introductory rate offer, and is available for a limited time only."

Terms for the headline rates have been increased from two to three years but the reversionary rate – which is the payments due after the discount period – have been increased.

For example, under one principal and interest offer, borrowers paid a variable rate of 3.75 per cent for two years before the loan reverted to 4.10 per cent.

Under the new offer, which applies from Tuesday, borrowers pay a variable rate of 3.75 per cent for three years before the loan reverts to 4.19 per cent.

Borrowers with a 30-year, $400,000 loan, would have monthly repayments of $1,852 during the fixed term with both loans.

But on-going monthly repayments for the new offering increase to $1,945, for a total cost of $697,043, or nearly $5,000 higher than for the original loan package.