How to break out of mortgage prison
Mortgage holders have been feeling the financial squeeze amid a campaign of interest rate rises from the Reserve Bank of Australia (RBA), which has put the official cash rate up in 11 of their last 12 meetings.
Those who locked in historic low rates at the start of the Covid-19 pandemic will suffer the brunt of all those rate rises when their fixed-rate terms expire, going over the edge of the so-called mortgage cliff.
RBA data in April predicted about 880,000 Australians would be affected by the end of 2023.
It leaves some of those borrowers stuck in mortgage prison, unable to refinance with another bank because they can’t pass the serviceability assessment (“stress test”) or they don’t have enough equity in the loan to refinance.
The nation’s banking regulator, the Australian Prudential Regulation Authority (APRA), has suggested adjusting affordability buffers in order to help.
That would effectively broaden the criteria by which prospective borrowers are judged.
An APRA spokesperson said while the current buffer was appropriate, changing economic conditions could spark a review.
“APRA closely monitors economic conditions as it continually reviews the appropriateness of its macroprudential settings,” the spokesperson said.
“Should risks to financial stability change, APRA will adjust its macroprudential policy settings accordingly after careful consideration and consultation with other agencies on the Council of Financial Regulators.”
However, the regulator also noted there were “exceptional cases where borrowers do not fit the standard approval process”.
“APRA’s prudential standards do not prohibit banks from lending to these borrowers; APRA expects banks to have prudent limits, controls and justifications for exceptions to policy and for these loans to be monitored closely,” the spokesperson said.
On Friday, Westpac announced it would allow some people looking to refinance their mortgage to be tested under a “modified Serviceability Assessment Rate” if they do not pass the standard serviceability test.
To be eligible, customers must have a credit score of more than 650 and a good track record of paying down all existing debts over the last 12 months.
Mortgage comparison website Ratecity.com.au believe while it’s hard to pin down how many Australians are stuck in mortgage prison, it’s likely to be those who bought during the peak of the pandemic with a deposit under 20 per cent.
It’s also likely to affect those who borrowed as much as the bank would allow or those who’ve had a drastic change in circumstances.
Modelling from RateCity gives an example of someone stuck in mortgage prison: an individual earning the average wage with no kids, no other debts and minimal expenses.
“If they took out a 30-year loan in July 2021 with a big four bank, they could have borrowed an estimated $688,800 on an average variable rate of 2.60 per cent,” reads the analysis.
It’s estimated this would have been the maximum the bank would have let them borrow at a time when APRA required banks stress test prospective borrowers at 2.5 per cent – currently, it’s 3 per cent.
“Fast forward to today, they would currently have a remaining debt of $664,494, would be earning an estimated $95,481 … our analysis shows they will need to earn an estimated $23,759 (25 per cent) more than they currently do in order to refinance.”
Whether a borrower takes out lender’s mortgage insurance (LMI) can also impact their ability to refinance with another provider.
The one-off, non-refundable premium is applied to loans where the borrowed amount is more than 80 per cent of the value of the home, and can add tens of thousands of dollars to the cost of buying.
While the fee can be added to your home loan, the amount is determined by the size of your deposit, compared to the amount borrowed.
However, if the equity in your home remains less than 20 per cent at the time of refinancing, your new lender will likely make you pay LMI again.
RateCity research director Sally Tindall said it wasn’t game over for those in mortgage prison.
“Switch off the real estate app notifications on your phone, put your head down and concentrate on keeping your home loan repayments up,” she said.
“Refinancing might not be an option for you right now, but a rate cut may still be on the table if you call your bank and negotiate.
“Check what rate your lender is offering new customers for the same loan and if it’s lower than what you’re on, it’s a good benchmark to set your sights on.”
One of those in the industry pushing for the change is Rate Money chief executive Ryan Gair, who thinks removing the buffer altogether would trap fewer people in mortgage prison.
“APRA should have separate recommendations to regulate existing borrowers,” Mr Gair said.
“They should allow those looking to refinance to simply show that they can meet the repayments along the same lines as applying for a new loan and that your current income can still service the repayments.”
“Fortunately, there are solutions for borrowers coming off fixed-rate loans who will likely see their repayments double and for those stuck in a mortgage prison.
“While times are tough and interest rates continue to rise, consumers should do everything in their power to stay afloat and put themselves in a better financial position in the long run.”
To avoid mortgage prison, or for those unfortunately already there, Mr Gair recommends getting your property revalued now if you think its value will decrease.
“Most lender evaluations last between 90-180 days, so you can coincide it with your fixed-rate term ending,” he said.
“Doing this could be the difference between having enough equity to refinance.”
He’s also urged borrowers to consider moving to an interest-only loan, consolidating debts, and looking beyond mainstream lenders.
Minutes from the RBA’s May meeting, released on Tuesday, flagged further rate rises over coming years, with inflation not expected to hit the top end of the board’s target band by mid-2025 at the earliest.
Despite this, the minutes also show the board was divided over keeping the official cash rate on hold in May or raising it; ultimately, it was raised another 25 basis points to 3.85 per cent.
The RBA board meets again on June 2.