Trapped in 'mortgage prison'? Here's how to escape

It’s the dilemma every home buyer dreads: paying rising interest rates on their mortgage, while the value of their property ebbs away beneath them.

But some who rush to refinance discover that they’re actually mortgage prisoners – stuck on a high interest rate and unable to move to a lower one because the value of their home has fallen, and they don’t meet the tighter credit requirements brought in late last year.

“This is today a very real problem,” said Domain Home Loans chief executive Kareene Koh. “We’re seeing an increasing incidence of this amongst our customers.

“Maybe people bought when prices were at their peak and the buffer the bank had for their home loan was about 2 per cent over the interest rate at that time. But now, 12 months on, they’re looking to refinance, and that buffer is more like 3 per cent and that can push the serviceability requirement into another bracket while at the same time, they’re seeing the value of their home falling.

“The cost to service their loan has gone up, and the price of what they’re paying for has gone down. Those two things coming together might mean they can’t refinance.”  

Koh’s advice to anyone in this position, or who fears they might end up in this predicament, is to re-engage with their home loan provider as quickly as possible. It’s about the need to proactively try to manage the process, rather than doing nothing now and finding – too late – that you don’t have any options.

For the situation may only become direr later on, with the prospect of further interest rate rises, a rising cost of living, stagnant wages, and even more mortgage stress, which has been compounded by the Australian Prudential Regulation Authority’s (APRA) decision to increase the minimum interest rate buffer banks should use when assessing the serviceability of home loan applications.

“If you know your fixed rate is going to expire in a few months, act now, or at least make sure you thoroughly understand your position so you can arm yourself with information and have time to prepare,” Koh said. “And try to save more money for the rainy days ahead.” 

Talking to your lender as soon as possible if you’re having problems is also the advice of the Bendigo and Adelaide Bank. A spokesperson said, “We have a team of specialists standing by to assist customers in financial difficulty and explore their options.”

To try to avoid such problems occurring, it’s always a good idea to buy with as big a deposit as possible, to reduce the amount of the actual loan.

Paying down a loan as soon as the borrower is able is also wise, to keep the loan-to-value ratio (LVR) below 80 per cent, which may make it easier to refinance even if property prices tumble. 

Banking analyst Martin North, principal of Digital Finance Analytics, said there are now many people caught in this quandary. “The real mortgage prison story is where their own personal circumstances have changed and they’re having problems trying to service those higher mortgage repayments,” he said. 

“The Reserve Bank’s changes take about two months to percolate down to people’s accounts so they’re now beginning to receive the May and June increases, and there’s still at least two more to go. So, people are now getting quite desperate about what to do.”

He suggests home owners draw up a rigorous budget with their income and expenses to be able to prioritise spending more clearly, and cut unnecessary expenditure. Then they should shop around to find the best rates.

North says some banks are now suggesting their clients extend repayments from, say, 21 years to 30 years, to make them more manageable, but he advises against this. “It means you’ll be paying a lot more interest over the life of the loan,” he said.

It’s not an option, however, to just abandon the mortgage and home, as it is in the United States for ‘non-recourse borrowers’ with a practice known as ‘jingle mail’, where they leave keys in the mailbox for the bank. Another way forward might be for borrowers to try to increase their income, by perhaps taking on more work.

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At ANZ, a spokesperson says that customers are encouraged to get in touch with the bank for a home loan check-in as soon as they face difficulties. “That might help them find ways to get more certainty or flexibility, reduce their payments, pay off their home sooner, or access available funds,” he said.

Westpac hasn’t yet seen any increase in customers requesting hardship assistance, but a spokesperson said they are monitoring the situation carefully, expanding teams to better support customers as rates rise, and contacting borrowers coming off low fixed rates.

“Our customers have saved well during the pandemic with many building up a financial buffer to help soften the impact of rising interest rates,” said a spokesperson. “The majority have built up equity in their homes as a result of rising property prices and paying down their loans.

“At the same time, the job market is strong, and unemployment remains low, enabling customers to continue to receive a regular source of income.”

Meanwhile, more than three-quarters of people with home loans with the Commonwealth Bank are ahead on their mortgage repayments.