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How Close Australian Homeowners Are To The Edge Of A Financial Cliff

What’s the impact of nine consecutive interest rate rises on Australian homeowners?

A lot of numbers thrown around each time the Reserve Bank raises the cash rate seem abstract. An extra $77 a week on an average mortgage or 800,000 fixed rate mortgages due to expire in 2023 may be technically correct, but they don’t tell you how badly homeowners are potentially hurting right now.

One answer can be found in loan-to-value (LVR) data – and it’s an answer that should worry any homeowner who’s feeling the pinch and hasn’t recently refinanced their mortgage.

What is LVR and why does it matter to your mortgage?

With apologies to those of you who know your LVRs from your LMIs, the loan-to-value ratio is how much you’ve borrowed on your mortgage relative to the value of your property.

• Banks and other lenders use LVR to calculate your loan risk.

• Lenders aren't keen on LVRs above 80%, so if your property is worth $1m, then $800k is probably the limit of how much your bank will lend before it gets a bit nervous.

• Anyone with an LVR above 80% will probably be charged Lenders' Mortgage Insurance (LMI).

Be aware: Lenders' Mortgage Insurance is a one-off payment that can run into thousands of dollars, making it a lot more difficult to refinance your home loan.

You should be aware that LVR isn't fixed. It can go up and down. This depends on:

• How much is left on your principal mortgage (the amount you've borrowed before interest is applied). The more you pay off relative to your property's value, the lower the LVR.

• The value of your property. If it goes up, then there's a good chance your LVR goes down. But if the value of your home goes down, your LVR is more likely to rise.

• Your interest rate. If your interest rate has gone up, the value of your property has gone down, and you've not paid off much of your principal mortgage, then a high LVR is more likely.

Also, your LVR can exceed 100%. That will tip you into negative equity, where your property is worth less than the amount you've borrowed. This really isn't a place you want to be.

It's also worth noting that the people most likely to be affected by LVRs moving upwards and towards negative equity are more recent buyers who've still got a lot of the principal loan to buy off.

How are the LVRs looking for Australian homeowners?

Two words: not good.

To explain why, let's first look at the volume of inquiries Compare Club receives from people wanting to borrow more than 80% of the property value. 

There are two things to note in the graph below. Firstly, the large number of inquiries with an LVR of 91% or higher suggests a lot of people may not be able to afford the property they want to buy (it's worth noting that these are just inquiries. A much smaller number will actually make it through to sale).

Secondly, the number of people with a 'good' LVR of 80% or under briefly shot up sometime around November 2020. There were also fewer inquiries from would-be homeowners with a high LVR of 91% and above.

This coincides with the Reserve Bank of Australia's record low cash rate of 0.1%. It's not difficult to conclude that this temporarily allowed more people to access loans that had previously been out of reach.

When you view the same inquiry volume but for people looking to refinance their property, you see that high LVRs only made up a small number of the overall inquiries until October/November 2022.

This was also when the number of mortgages with an LVR of 91% of above shot up, and the number of inquiries with an LVR of 80% or less dipped quite substantially.

Now let's put these two graphs side by side.

What stands out here is the inquiries of 91% LVR or above spike almost two years after the number of 'good' LVR inquiries increased. 

Many of the most competitive rates in November 2020 that were widely accessible were two-year fixed-term loans with a 2% interest rate or thereabouts. This first group of ultra cheap fixed rates started to expire in November 2022 – around the same time the volume of inquiries from refinancers with an LVR of 91% or higher increased.

Worryingly, the 91% LVR loans consistently comprise more than 20% of Compare Club inquiries. If we ignore the downturn in December, when most of the mortgage industry goes on holiday, it suggests this trend is still playing out.

If we then zoom in a little further to look at only the 91% or negative equity inquiries, the graphs look even more stark.

We can see a couple of big spikes of 91%+ LVR enquiries in June 2022 and Jan 2023.  And they're followed by a bump in negative equity inquiries. 

What does the home loans data around LVRs actually mean?

A word of caution: this trend is still playing out as we're only at the start of the fixed rate expiry cycle. But here's our reading:

• There were a lot of heavily leveraged homeowners who saw their LVR jump following the first RBA rate increases.

• The impact of monthly interest rises wasn't really felt until the start of this year.

• We're now at the point where property prices have dropped, cheap fixed-rate loans are starting to expire, and interest rates have risen. This is pushing a larger number of people towards negative equity.

Be aware: The serviceability buffer is also starting to play a part here. Anybody applying for a home loan is assessed on their ability to repay the loan at 3% higher. So if you're applying for a loan with a 5% interest rate, you'll actually be assessed on your ability to repay at 8%.

And if you're close to negative equity, you're going to find it a lot harder to refinance. This is what Compare Club CEO Lance Goodman calls "mortgage prison".

The bottom line

The above data is a small sample of the market and it's only people who've reached out to Compare Club brokers. But if these numbers are nationally representative, it suggests nearly one million homeowners in Australia could be at risk of entering mortgage prison.

But ... don't lose hope. If your fixed-term mortgage is expiring in 2023 get in touch with a financial professional or mortgage broker now. You'll at least be better prepared.

Mortgage broker Sophie Matthews, has some very useful tips for tackling your mortgage, such as:

• Negotiate with your bank.

• Shift your payments to fortnightly.

• Attack your principal mortgage: the lower your loan, the less interest you'll pay.