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Mortgage prisons and forced sales: How to avoid 3 cash rate risks

·5-min read
Compilation image of house hanging on a hook over a cliff and a pile of $100 notes
There are three looming debt dangers you can easily avoid. (Source: Getty)

Interest rates are widely forecast to go up 50 basis points again today, potentially adding another $160 a month to an average $600,000 mortgage.

That will take the total additional repayment pain since May to $707.

The good news is that the Reserve Bank of Australia (RBA) may now sit back and survey its handy work… (probably) 225 basis points of hikes in just six months. Two-thirds of economists surveyed by Finder expect it.

Read more from Nicole Pedersen-McKinnon:

The bad news is, we are all contending with the expensive effects.

But in the bigger-picture, home-safety front, there are now three serious signs for which to watch out.

And three ways to act to get yourself out of danger of falling victim to each one.

Watch out: Being locked out of a refinance

A record $18 billion was refinanced in June, as tens of thousands of Aussies seeking to escape rate rises ditched and switched lenders.

Lenders, meanwhile, slashed variable rates to try and either keep or win customers.

In a secret behind-closed-doors mortgage war, Yahoo Finance has had word of discounts as high as 2.4 per cent off the advertised rate.

That’s unprecedented. And an opportunity.

The thing is that you still have to be able to afford the repayments.

Unless you are able to negotiate a market-beating deal with your existing lender, applying for a refinance with a cheaper new one puts you back at square one; you have to meet stringent income serviceability tests to get a loan across the line.

These are stricter still as of the end of last year. The Australian Prudential Regulation Authority (APRA) imposed a 300-basis-point stress test.

In other words, you needed enough capacity to meet repayments 12 rate rises higher. And that’s now on top of sharply higher interest rates.

Incidentally, this means that the people who borrowed very recently have had their wages theoretically tested for what’s happening.

People who borrowed earlier were only stress tested up to 250 basis points.

Even so, that income ‘cushion’ shrinks every time the Reserve Bank strikes.

Unless you are in the enviable (and unlikely) position of your income rising accordingly.

How then do you act to combat this?

When it comes to a refinance, you really are racing against the clock… so the sooner you apply, the more likely you are to be approved.

Remember, the most competitive advertised interest rate, for a quality loan product, is as of today, still down near 3.6 per cent.

If you hold less than 20 per cent equity though, refinancing may not yet be a viable option. You won’t be able to access the cheapest interest rates and you will likely have to repay extortionate lenders’ mortgage insurance.

Indeed, in what is becoming known as ‘mortgage prison’, with property prices retreating (and with higher rates), you may well not be able to refinance.

Teenager showing anxiety holding bill
Consecutive interest rate hikes are pushing more and more homeowners into mortgage stress. (Source: Getty)

Watch out: Being locked into negative equity

Here, people who borrowed most recently are in the most danger. APRA data say that in the six months to March, $112 billion worth of mortgages – about 176,000 according to RateCity analysis – were taken out with a deposit less than 20 per cent.

And that’s not a happy position right now. And for borrowers who’ve owned longer, don’t forget house prices rose steeply higher on the pandemic-induced great relocation.

Negative equity is the term for owing more than the value of your house.

It means that, should you become a forced seller, you would still have a debt to the bank.

To make doubly sure they are not out of pocket, lenders’ mortgage insurance protects the banks and not you in this case, but you pay the premiums.

So don’t become a forced seller.

Do make sure you are still able to meet repayments.

With anything in money management there are two main levers:

1.Your income

2.Your expenses.

Today, upping your income in any way possible is a beautiful thing. And note there are almost 300,000 new incorporated small businesses since the beginning of the coronavirus crisis, as droves of entrepreneurial Aussies look to turn a side-hustle into a significant top-up.

With inflation running at 6.1 per cent and the Fair Work Commission granting millions of Aussies a similar pay rise, and unemployment at almost a 50-year low, might it be time you had a pay rise conversation too?

If nothing can realistically be done, you might be a prime candidate to ask for loan leniency. Remember, every lender must have a dedicated financial hardship department.

As I say, confessions are getting concessions right now. And repayment holidays or amended debt schedules can no longer hurt your credit score.

Watch out: Falling off the fixed rate cliff

$180 billion in mortgages are rolling off fixed rates in the coming months. Many of these were down near 2 per cent, fixed at a time when the official rate was at an emergency setting of just 0.1 per cent.

It is likely to be at 2.35 per cent by this afternoon – and variable rates a margin above that.

But a fix may well not be an option. Short-term rates have risen dramatically. For example, the Commonwealth Bank of Australia lifted them 140 basis points at once for some of their fixed products a couple of months ago.

But look a little longer and four- and five-year fixes are actually lower and more attractive.

Before you lock it in, that is because the expectation is for the cash rate to fall.

In fact, that rate is forecast by money markets to fall as soon as the middle of next year.

And that is good news all around.

Nicole Pedersen-McKinnon is the author of How to Get Mortgage-Free Like Me, available at www.nicolessmartmoney.com. Follow Nicole on Facebook, Twitter and Instagram.

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