Banks and mortgage brokers have been put on notice that they will be pursued by the Australian Securities and Investments Commission unless they tighten up their selling of interest-only loans to home buyers.

Key points: Investor-only loans still being sold to borrowers approaching retirement age

Investor-only loans still being sold to borrowers approaching retirement age ASIC will investigate individual loan files to ensure borrowers are not being ripped off

ASIC will investigate individual loan files to ensure borrowers are not being ripped off A decline in investor loans offered by the big banks is being offset by smaller lenders bulking up their market share

While ASIC's interim review found major banks have cut back their interest-only lending, this has been offset by smaller lenders increasing their share of that market.

The ASIC review found that, despite tighter scrutiny from regulators, borrowers approaching retirement age were being targeted for the more expensive loans, which they would struggle to repay.

The other key concern raised by ASIC was that borrowers using mortgage brokers were more likely to sold interest-only loans than those dealing directly with a lender.

The crackdown on interest-only loans has been driven by the three key financial regulators — ASIC, the Australian Prudential Regulation Authority and the Reserve Bank — over fears the practice has encouraged highly speculative borrowing and loaded banks' balance sheets up with an unacceptable level of risk.

While interest-only loans are popular with investors looking to negatively gear a property portfolio, ASIC's focus has been on the marketing of the loans to owner-occupiers.

Owner-occupiers being sold expensive, inappropriate loans

"Responsible lending laws require lenders to assess the income and expenses of borrowers, what will be required and what are their objectives and are they able to deal with the repayments when they come to the end of the interest-only period," ASIC deputy chair Peter Kell said.

"It is important for consumers to understand that the reduction in price will finish at some stage and it will become an even more expensive loan with a higher repayment.

"The bigger question [for lenders] is why are you recommending such a loan when for most it will be the more expensive option."

Mr Kell said the future serviceability of loans was particularly important for borrowers approaching retirement and both lenders and brokers had to take into account the borrower's ability to meet higher repayments down the track.

ASIC started its surveillance in April, around the time APRA tightened the screws on the banks demanding that interest-only loans be restricted to 30 per cent of new residential mortgages.

At the time the loans made up around 40 per cent of the big banks' loan books, a figure APRA described as "high" compared to international and historical standards.

The ASIC review of 16 key lenders found interest-only loans provided to owner occupiers dropped from $19 billion in the September quarter of 2015 to $14.3 billion in the June quarter this year.

The study included the large, mid-tier and smaller banks as well as non-bank lenders and credit unions.

Individual files held by brokers and lenders to be examined

ASIC now plans to trawl through individual loan files to ensure that lenders are providing interest-only home loans in appropriate circumstances.

The study follows research from investment bank UBS, which found up to a third of borrowers with interest-only loans may not realise they have them.

"ASIC will carefully review cases where owner-occupiers have been provided with more expensive interest-only home loans, to ensure that consumers are not paying for more expensive products that are unsuitable," Mr Kell said.

"When you see a higher amount of these loans, you need to ask the question, we need to see the files and make sure brokers are not providing loans that are not inappropriate.

"The spotlight has been firmly on interest-only lending for some time, and there are no excuses for lenders and brokers not meeting their legal obligations.

"While interest-only loans may be a reasonable option for some borrowers, lenders must make appropriate enquiries into the needs and financial circumstances of their customers, and they must be able to demonstrate that they have done so."