Are you a mortgage prisoner?

Facing up to (difficult) facts

Like Jodie and Steve, it’s easy to feel trapped. Many of us often feel this way when facing the seemingly relentless need to service a home loan. But some borrowers are literally trapped. These homeowners are now being referred to as ‘mortgage prisoners’. They are in this situation due to a ‘perfect storm’ of three home loan factors:

steadily rising interest rates
falling house prices and
reduced ability to service loans

Let’s look at each of these pressures.

Interest rates

It is well reported how quickly rates are rising. They stayed at record lows while inflation was low, but post Covid lockdowns, with heightened economic activity, the Reserve Bank of Australia has raised the official cash rate seven times, from 0.1% in May to 2.85% currently, with a further increase in December expected. This official cash rate is now reflected in retail mortgage rates.

Falling house prices.

Due to the normal tension between supply and demand, higher repayments have led to fewer buyers, so Australian house prices have dropped quite dramatically since their pandemic highs – by 7.4 % in Sydney, 4.6% in Melbourne and 10.1% in Darwin (CoreLogic report September 2022).

Loan serviceability

The Loan to Value (LVR) ratio offers a mechanism for lenders to try to ensure that borrowers can meet ongoing interest, or principal plus interest, repayments. It is calculated by dividing the proposed loan amount by the agreed value (or purchase price). The lower the LVR, the more likely you are to secure a loan. Lenders also require minimum repayments which cover interest owed, plus a percentage of the value of the loan, to ensure the loan is actually reducing. If you can’t meet such expected minimum repayments you will struggle with the loan serviceability requirement when you try to change lenders or to refinance a loan which is expiring.

According to recent research from AMP, some 64% of homeowners are worried about being able to keep on top of their mortgage repayments. The refinancing of home loans has increased by 26% over the past year (to August), with many more fixed interest loans due to expire in the next 12 months.

To further complicate matters, there is a phenomenon described as a ‘loyalty gap’ which has (according to investment and advisory group, Jarden) widened to a record level.

What does this mean?

The ‘loyalty gap’ refers to rates offered to entice new borrowers, as opposed to the rates offered to existing customers including those who try to refinance with the same institution. It’s worth noting that what is a ‘best rate’ advertised by your bank may not necessarily be the ‘best rate’ on offer to you by this same lender.

It’s worth knowing that such a gap exists if you, too, are facing the need to refinance or are currently comparing rates if your repayments are becoming unmanageable. Many banks have a ‘retention team’ who can work with you to ensure you stay with them, rather than going to other lenders. It’s always worth seeing what’s on offer with this team, in addition to checking other lenders.

A recent consultation with Jodie and Steve drew the current challenges of having a mortgage in retirement to our attention.

Spoiler alert! There is a happy ending to this story, but first they had to face the painful reality of how quickly their repayments had risen. And how unaffordable their home loan was starting to become.

Jodie and Steve had downsized three years ago and used the proceeds to pay down debt. They now live in an apartment in western Sydney, purchased for $850,000 just before the pandemic hit. They supplemented the purchase of this home with a $200,000 fixed rate loan (at 2.5%).

Things have now changed and the loan needs to be renegotiated.

The value of the property has decreased to $765,000. They have paid off some of the principal, so are seeking a $150,000 loan. The best rate they can currently find is for 5.25%, fixed for three years. They will need to service $900 monthly in principal and interest, or $10,800 per annum.

Or if they shift to a variable loan, (they have found a rate of 4.40%), they will need to come up with $752 monthly or $9024 per annum, but without the security of the fixed three-year arrangement.

Although they have a combined amount of $350,000 in super and a small amount of cash, Jodie and Steve, who are on a part Age Pension, were concerned these higher annual repayments will force them to cut their spending to the bone to cover their mortgage.

After talking to an adviser, they have decided to buy themselves some time. This allows them to watch how long interest rates will continue to rise, without committing to a course of action that reduces their lifestyle too dramatically.

They have selected the $150,000 variable loan. And are transferring $40,000 of their super into this redraw (equity access) account. This means they can buffer the loan and reduce payments, but still have ready access to these funds, if and when needed.

They believe they have also tackled the ‘loyalty gap’ by changing from their long term lender to a second-tier bank with lower rates. And they are determined to watch the market closely to make sure that the rates they are paying remain comparable with other lenders.

They have also had an informative discussion about ‘break’ fees so are fully across any penalties if they decided to change lenders again in the near future.

Both Jodie and Steve would like to be able to pay off their mortgage sooner rather than later. This is outside their control right now, but they are looking into the detail of how much more they can earn without affecting their part-Age pension entitlements. They are thinking that the expanded Work Bonus rules mean that some short-term project work will be a solution.

CTA

Like Jodie and Steve, more than one in five of our consultations are with people who still have a mortgage on their home.

Having the ability to project their spending was key to Jodie and Steve’s decision-making. During their consultation with our adviser they were also able to see how using super to buffer their new mortgage might affect their fortnightly pension income. The combination of potential spending changes and Centrelink rules is very complex, so the opportunity to compare different scenarios using the Retirement Forecaster is a great way to clarify your options.

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Are you a mortgage prisoner?