Three signs you are in mortgage prison and how to break free

Mortgage prison is a finance and property phrase that has emerged from the glum depths of interest rate stress.

It means a homeowner is stuck with their current mortgage and interest rate, and do not have the power to change to a better deal.

Being in a mortgage prison is generally not a permanent state, because life alters and so does inflation and cash rates, but enduring it, even in the short term, can be immensely worrying.

Here are the three signs you are in mortgage prison and how to break out.

What causes a mortgage prison?

Mortgage prison refers to entrapment in your current interest rate and loan contract. Being under financial pressure, wanting to move lenders but finding you are glued to your current lender, are the three signs you are in mortgage prison.

It does not mean you signed a bad deal at the time, mortgage broker Rebecca Jarrett-Dalton, founder and director of Two Red Shoes, says. However, when your financial, family and employment circumstances change, the bars can suddenly slam shut.

These circumstances can include opening pay-later retail accounts, including Afterpay and Klarna, a reliance on credit cards, becoming self employed during the early period of a loan, having more children, or taking on other monetary obligations that indicate you are or will be stretching to meet repayments across many responsibilities, lessening your status as a safe bet.

“The lending criteria can change so they do not accept the income type you have anymore, or the mandatory minimum living expenses have gone up beyond what your living expenses are,” Jarrett-Dalton says.

Believe it or not, lenders do not want you to default on your mortgage and repossess your home. They do not want to end up with the bad publicity for this, either, Jarrett-Dalton says.

Therefore, this different lender will not take you as a refinance customer, and you have to stay with the lender you are unhappy with, paying a loan sum you can’t afford or is causing you discomfort.

Why won’t a bank refinance my loan?

Jarrett-Dalton explains that this comes down to how you present to the lender that you want to refinance with.

She said lenders add a “buffer” of 3 per cent on top of the current interest rate, to ensure you can meet repayments without bother should the rate go up several times. They run your personal figures against this hypothetical higher rate.

When you get rejected for refinancing, it is because the lender feels that your current debts and obligations are so great, you would not be able make those higher repayments.

“You cannot control rate creep – what puts you in prison is the fact the bank behind the scenes starts to creep your rate up. Of course you took on something fabulous, but it can become less than fabulous and you are unable to get out of it.”

How do you break out of mortgage prison?

“Circumstances can change rapidly in your favour as they do against,” Jarrett-Dalton says.

“Changes in your own circumstances are also the biggest driver of being able to exit and get out of jail free, as well as a change in lenders’ policy and definitely a drop in interest rates are helpful.”

In the beginning, do not borrow to the maximum where possible – easier said than done with record house prices in many capital cities, and a $1.5 million median in Sydney, she says.

“It is also about not taking additional commitments after the fact, so if you consider your circumstances today and make changes to those circumstances, you might be accidentally putting yourself in a place where you are stuck.”

She says cutting back liabilities will help you to present as a better refinancing candidate.

“If you have a credit card, drop it back to the limit and use it only as an emergency tool,” she says, as well as getting rid of pay-later finance and where possible, maximising income.

Before you come to grief, contact the bank to speak to their hardship team. They all have them. But first, try getting into a discussion with their retention staff, who ought to do what they can to keep you, but under improved loan terms.

“If you are serious about trying to leave, you can ask for a discharge form and that will get their retention teams’ attention,” Jarrett-Dalton says.