Why falling house prices aren’t the good news that first home buyers think

Home owners are rushing to refinance as mortgage rates rise, but their chances of getting a better deal could shrink as property prices fall.

Home buyers who purchased close to the property market peak could find themselves in “mortgage prison” as values decline, experts say, because reduced home equity and rising interest rates hit their ability to refinance.

Sally Tindall, RateCity.com.au research director, said: “The record-breaking property price increases seen in 2021 mean people who bought over a year ago are typically flush with equity at this point and won’t have a problem meeting a serviceability test when refinancing.

“However what goes up must come down … and people who bought last year, particularly in the second half, or earlier this year, may find their equity drop significantly.”

On top of factoring in higher interest rates and increased living expenses when looking to refinance, home owners also had to factor in the “moveable beast” of equity and the higher mortgage serviceability buffer now used by the banks to stress test borrowers, said Tindall.

“Property prices haven’t fallen that much yet, but it will become an issue,” she said, mostly for those who bought with a smaller deposit.

If property prices were to fall more than 20 per cent in Melbourne and Sydney by the end of 2023, as forecast by NAB, those who purchased median-priced houses with a 5 or 10 per cent deposit in December last year would find themselves in negative equity when their fixed term ended, RateCity modelling shows.

Those who purchased with a 20 per cent deposit, and fixed with the big banks for two years, could see their equity reduced to just 3 per cent in Sydney and 4 per cent in Melbourne, despite two years of repayments. That is based on an owner-occupier paying principal and interest over 30 years.

Tindall said those whose equity dropped below 20 per cent would need to take out lenders mortgage insurance if they chose a new lender, a cost which would erode any savings they stood to gain from refinancing. For those in negative equity, it would be near impossible to change lenders.

Tindall said other banks are forecasting smaller price falls, and the majority of home owners who fell into negative equity would be able to ride out the storm. She encouraged those unable to keep up with repayments to talk to their bank about a hardship policy.

Shore Financial senior credit adviser Derek Farmer already has “a good chunk” of Sydney clients who would like to refinance to a lower rate, but can’t meet the higher serviceability requirements introduced by the banks late last year.

For example, he said, a client paying 4 per cent on their mortgage could find a lower, more affordable rate of 3 per cent. But due to the 3 per cent serviceability buffer they would be assessed on their ability to handle a rate of 6 per cent, and may not qualify for such a new loan.

“We call them mortgage prisoners, they’re basically stuck with their existing lenders,” he said.

As property prices fall further, it would become harder to refinance for those who bought at or near the peak of the market, Farmer said, particularly those who purchased with a lower deposit.

He saw it after the 2017 market boom, with some clients struggling to refinance if their loan to value ratio went above 80 per cent. While they could still switch lenders, the added cost of the required lenders mortgage insurance outweighed the potential saving from a lower rate.

Melbourne mortgage broker Will Unkles, director of 40Forty Finance, said it would generally be first home buyers who purchased with lower deposits in the past six months most at risk of falling into negative equity.

While few clients had seen sizeable declines in their equity the last time prices fell, the market looked set for a stronger and longer downturn this time, he added. He also urged home owners to factor in their potential reduction in equity when considering whether to refinance in the cooling property market, noting it was often overlooked.

Those looking to refinance should first contact their existing bank and see if they could negotiate a better rate, he said.

Tindall said anyone looking to refinance should be mindful of fees and wary of cash-back deals that may not be as attractive in the long term as a simple lower rate.

She said one mistake some borrowers made was to refinance their loan back to 30 years. While that would reduce their repayments, it would see them pay more interest over the life of the loan.