This article originally appeared on Nectar Mortgages and has been published here with permission.
According to the Reserve Bank of Australia, over 800,000 mortgages will be rolling off their record-low fixed rates this year. Many borrowers on an expiring fixed rate will want to refinance their loans rather than letting their mortgages revert to their current lender’s (higher) standard variable rate.
However, some borrowers may find themselves stuck with their current lender in what is being referred to as ‘mortgage prison’.
What Is Mortgage Prison?
The Australian Prudential Regulation Authority (APRA) requires lenders to put new loan applicants through a financial stress test. The test adds three per cent to their actual market rate and the lender determines if the homeowner’s income would be sufficient to repay their mortgage at this increased rate; this is called a serviceability buffer test.
Due to recent interest rate increases, some borrowers are failing serviceability tests after the three per cent buffer is added. Because of this, lenders reject these borrowers’ applications to refinance, forcing them to stay with their current lender. In other words, they are stuck in ‘mortgage prison’.
How Have Lenders Responded?
Several industry members, including lenders, mortgage brokers, association heads and politicians, do not agree with APRA’s policy, saying that this serviceability test is too high in the current market.
As such, a growing number of lenders have been providing exceptions to their credit policies to make it easier for borrowers to refinance their mortgages.
APRA has warned lenders to be prudent with their exceptions, stating that lenders allowing large volumes of exceptions will be subject to heightened supervision.
What Does This Mean For Borrowers?
If you’ve been told you don’t pass a lender’s serviceability test, and therefore can’t refinance your loan immediately, here are some steps you may consider to get out of ‘mortgage prison’ or mitigate the cost of higher repayments:
1. Book A Mortgage Review
It always pays to get a second opinion. If you think you won’t pass a serviceability test, it may still be possible for you to refinance. The best way to check is by booking a home loan review with a mortgage broker.
A mortgage broker will be able to assess your current financial situation and explain what options are available to you.
If your loan-to-value ratio (LVR) is above 80% (perhaps your property value has declined in the recent market downturn), you may still have the option to refinance to a more affordable loan. However, your choices will be limited to higher LVR offers and you will likely incur Lenders Mortgage Insurance (LMI) charges. While this can impede refinancing and keep borrowers stuck, you can include LMI in your loan amount, avoiding upfront payment. Additionally, the potential savings from switching lenders might compensate for the added cost. Ask your broker to evaluate the potential savings from switching before making a decision.
A broker could also talk to your lender on your behalf and work out ways to downsize your loan, remove certain expensive loan features or discuss the possibility of repricing your loan.
To find out what your options are, contact a Whiteroom broker and book a mortgage review.
2. Review Your Budget and Spending
If your expenses or spending habits have crept up since you first took out your mortgage, now could be a good time to see where you could tighten the purse strings, just a tad.
Consider putting a pause on expenditures like subscription services and ordering takeaways. You might also consider talking to your service providers (like your electricity and phone company) and negotiating for better deals.
If it’s been a while since your last raise at work, you might consider speaking with your employer to request an increase.
3. Work on Your Existing Debts
When you apply to refinance, lenders will also look at your other debts.
If you have credit cards, personal loans, student debt or car loans, work on getting them under control as quickly as possible. Prioritise paying off debt with high interest rates like credit cards. Doing this could improve your chances of approval for a loan refinance.
Even simply reducing your credit card limit can make you look lower risk in the eyes of a lender. This is because lenders tend to look at credit limit as potential debt, even if you don’t max it out each month.
4. Consolidate Your Debts
Rising interest rates affect all types of lending, not just mortgages. So, if you have other debts like credit cards, car loans or personal loans, you could consider consolidating them into your mortgage at a lower interest rate. This could help you free up some money in the short term, which you might use for other expenditures such as groceries and utilities.
However, consolidating other debts into your mortgage will increase your total loan value, meaning you could end up paying more over the long term. Debt consolidation is usually considered a short-term strategy and you should consult with a mortgage broker as to whether it’s the right option for you.
Find out more about debt consolidation here.
In summary, being prepared for interest rate rises is about being comfortable with your buffer. If you don’t feel comfortable, remember that we are here to help you. So please take advantage of our expert mortgage broking services and get in touch.
