Mortgage Prisoners Explained; Why more Australians are finding themselves trapped in ‘mortgage jail’
This could trap new homebuyers with smaller deposits in a sticky situation, known as mortgage jail, as the real estate market crashes.
Here we unpack what a Mortgage Prisoner is and how to get out if you get trapped.
What is a Mortgage Prisoner?
Mortgage prisoner is the appropriate term for a borrower trapped on their current mortgage who is unable to refinance their loan.
There can be a mix of factors leading to a borrower being trapped on their current loan, including declining home values, interest rate hikes, or changes in income.
Finance Brokers Association Australia director Peter White said banks assess a borrower’s “functionality” or how much you can afford to pay at a different rate.
For example, interest rates might be 5%, but the lender will consider your ability to pay up to 8%.
Not only are the current interest rate hikes pushing more people into the trap, White said banks have “a bad habit of repricing the back book.”
“They’re looking at existing customers and putting their home loan rate 0.45 to 0.7 percent above what other people are paying,” White said.
This means that people who are already in mortgage jail become even more trapped and White warned that more and more people are getting trapped.
Why are more people becoming mortgage prisoners?
Interest rate hikes are the common denominator of falling house prices and thus more and more people being trapped in their home loans.
So now that interest rates are expected to continue to rise and house prices continue to fall, more borrower loan-to-value ratios will be wiped out.
The loan-to-value ratio refers to the value of a home relative to the amount of money borrowed on a home loan.
For borrowers with a small deposit, if the value of their home declines and their equity (or more simply, the share of the home they own) falls below 20%, the loan-to-value ratio could change.
The higher the loan-to-value ratio, the greater the risk the borrower becomes and the lender is less inclined to allow him to refinance his loan.
“They will likely have to pay mortgage insurance to lenders, a cost that can run into the tens of thousands of dollars and could easily offset any savings made from refinancing,” RateCity.com.au said.
“In some cases, lenders might decide not to take them at all because of their equity position.”
Why are real estate prices falling?
Basically, as interest rates rise, mortgages become more expensive.
People will have less money from the bank to spend and will be competing for cheaper properties, which means the market has to match that – which equates to lower property prices.
The NAB expects property prices to fall by 20% in Australian capitals and the RBA is expected to raise the spot rate again.
“Every time the RBA raises rates, the maximum amount people can borrow from the bank suffers, and with a number of rate hikes potentially pending, house prices are likely to continue falling,” RateCity.com.au said director of research, Sally Tindall.
“During the boom, ‘fear of missing out’ drove house prices up. Today, the “fear of entering” has the opposite effect.
Will interest rates continue to rise?
The RBA is still trying to fight inflation and says it “will do whatever it takes to get there”, meaning more interest rate hikes are on the horizon, but no word yet to what extent.
“The size and timing of future interest rate increases will continue to be determined by incoming data and the Board’s assessment of the outlook for inflation and the labor market,” Governor Philip Lowe said after the latest increase.
White predicts interest rates will rise another 75 basis points to 3.35%, which means home loans will hit around 5%.
With house prices continuing to rise and fluctuating, White added that borrowers can be “trapped very quickly” if they don’t know.
So what do you do to avoid becoming a mortgage prisoner and what do you do if you are?
Tindall said anyone stuck in mortgage jail should always negotiate with their lender to get a better rate on their loan.
“This will help them make their monthly, and potentially additional, payments so they can get out of mortgage jail sooner.”
White said fixing your rate is an option to keep the future secure for a while, something some borrowers have been doing during the pandemic as interest rates remain low.
Otherwise, White recommended “just riding the wave” through rate hikes, but more importantly he said to seek independent financial advice from a mortgage broker because there is no one-size-fits-all answer.
“There’s no easy answer to that. It’s about getting the best advice possible and getting the best outcome,” he said.
“You have to look very critically and in detail at your situation and what you want to do, like renovating, going on vacation, buying a new car, all those things that you have to weigh.
“This is where it’s important to get a professional to help you.”
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