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How Much More Mortgage Misery Will Australian Homeowners Face
The days of a 2% or even 3% mortgage rate are long gone. In eight months we’ve gone from the lowest cash rate in the Reserve Bank’s history to the fastest interest rate rises since 1994.
But these stats don’t really matter to homeowners right now.
👁️ They’re looking at the monthly mortgage repayments wondering just how many more interest rate raises are ahead and how much extra it’ll cost them.
🔮 Nobody’s got a crystal ball but there are some very clear signs as to which households could feel the pinch more than others.
🔍 Here’s what to expect.
Why do some homeowners become “mortgage” prisoners?
November’s increase was significant because it meant that the cash rate has now risen by 2.75%
😮 This takes interest rates past the mortgage serviceability buffer from two years ago, when home loans were available for as low as 1.79%.
Lenders use a serviceability buffer to assess your ability to afford your mortgage if interest rates rise.
In November 2020, that buffer was 2.5%. That means a bank would approve a 1.79% mortgage if they felt confident the homeowner could still afford repayments at 4.29%.
Today the serviceability buffer is 3% and you won’t find a loan under 4%. That means that anybody taking out a new mortgage - whether they’re buying or refinancing - will be judged on whether they can pay off a loan that will be anywhere from 7% upwards.
🧮 Let’s put that in real terms. For the example below I’m using a $600,000 25-year principal and interest mortgage.
Say somebody took out a 1.79% two-year fixed term mortgage in November 2020 that’s just expired.
At the time of writing, the cheapest variable rates on Compare Club’s panel is 4.04%.. That’s an extra $698 dollars a month. Or $8,376 a year.
But the bank is looking at this person’s ability to repay at 7.04%. Which would be an extra $1,774 a month from what the homeowner was originally paying at 1.79%.
So, the homeowner rolls off their ultra cheap fixed term mortgage into a variable rate that’s uncomfortable – say somewhere in the low fives – but they’re unable to refinance because of the serviceability buffer.
😔 And that’s why Australia looks set to see a spate of mortgage prisoners over the coming months.
The double whammy: rising rates and plummeting property prices
Rising interest rates aren’t the only changes putting pressures on homeowners. House prices are also dropping.
So why is this also a problem for homeowners?
Higher mortgage payments combined with dropping property prices means the loan-to-value ratio (LVR) will have changed significantly in the past 12 months.
Banks look at LVR when assessing how risky a home loan is. The closer the loan is to the value of the property the more nervous a lender will get.
When a LVR goes over 80% – that is the loan is more than 80% of the overall property value - the bank will probably insist on the homeowner paying Lenders’ Mortgage Insurance.
LMI doesn’t protect the homeowner. It’s insurance for the lender. But the homeowner has to pay for it. It can be several thousand dollars.
🏠 So property prices are down across Australia and that means it’s going to be harder for some households to refinance.
Be aware: It’s not all doom and gloom. The Compare Club home loans brokers can see some suburbs that are bucking the trend in places such as Adelaide, Canberra and Alice Springs.
What other financial pressures will homeowners face in 2023?
The general outlook for the next few months is looking a bit rocky, although the Reserve Bank’s recent financial stability report suggests that the majority of mortgages should be safe.
🚀 We’ve seen how quickly the economy can change though.
More broadly, here’s what else homeowners need to keep an eye on:
Energy prices. They’re predicted to go up by 56% over the next two years and the federal government is coming under a lot of pressure to set an energy cap. Watch this space.
Wages. The good news: the Reserve Bank isn’t predicting mass layoffs. The bad news: they don’t expect wages to grow faster than the cost of living until 2024.
In real terms, that means households will see two big expenses – energy and their mortgage – go up but their pay packet will probably stay the same.
Now for the good news
This may seem like a bit of a gloomy analysis but it’s important not to sugar coat the situation.
🌈 But there is some good news.
Lenders are still very keen to bring new ‘good’ homeowners onto their books. Some banks are offering lower rates and as much as $5,000 cashback for refinancers.
Don’t just look to the big banks. Some second tier banks or specialist lenders will have different risk appetites. It’s best to speak to a mortgage broker to see what’s out there.
The bottom line
It’s going to be a tough few months ahead for homeowners but the important thing is not to panic.
🛒 There are a lot of lenders all competing for your business. Even if you’re six months out from your mortgage expiring, start speaking with your bank and a mortgage broker.
👛 The more proactive you are, the more likely you’ll be able to get a grip on some of your biggest costs.
