5 reasons it’s a scary time to be paying off a mortgage

I’m told roughly a third of all Australians with mortgages are on the ‘edge of stress’. That is, a rate rise here, or a pay cut there, and they’re vulnerable to defaulting on their repayments.

There are never any guarantees you’ll be able to sail through your home loan repayments without incident, but, recently, a few things have happened that have made life a little scary for borrowers.

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Let’s go from most scary to least scary, or maybe it’s the other way around? You decide!

Rising interest rates

You may have heard me talk about the US 10-year Treasury bond. I know, I know, it’s as about exciting as watching the grass grow! Who cares about the 10-year Treasury bond, right?

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The thing is, Australia’s major banks track its movements. Indeed all but the National Australia Bank used the rising 10 year bond as an excuse to raise interest rates independently of the Reserve Bank a month or so ago.

Late last week the US unemployment rate came out. It was very low – under 4 per cent! That suggests the US economy is really starting to pick up some steam. And if indeed it is, that means there will be further upwards pressure on interest rates – including the 10-year bond rate.

And yes, you guessed it, that means more upwards pressure on Australian interest rates.

The Reserve Bank won’t be moving on interest rates anytime soon, but that’s kind of beside the point.

You see if the household saving rate continues to drop, the big four banks will also be forced to source funds (to use for home loans) from the expensive domestic short-term money market as well, and they will also pass that cost onto borrowers.

In short, there’s every reason to believe your bank will send you another letter in the post telling you that your mortgage repayments have gone up. That’s because there are still cost pressures coming from both here at home, and overseas, for the banks.

The only caveat here is that your repayments may not go up by much at all. Here’s hoping.

Tightening lending standards

Kenneth Hayne handed down his interim report on the first four rounds of the Banking Royal Commission a few weeks ago.

He said “greed” was to blame for a lot of the terrible banking practices that have been aired during the hearings so far.

There are now fears from some corners though that the final recommendations from the Royal Commission will lead to further tightening of bank lending, and, essentially, a mini credit crunch.

The banking regulator, APRA, along with international regulators, has already forced the banks to shape up – increase capital buffers, and limit credit growth to pure property speculators. That’s made borrowing harder.

You see if it becomes harder and harder to source money from a bank, right at the time when house price falls are starting to pick up pace because interest rates are rising… well, you don’t need to be Einstein to realise this won’t end well.

Home equity

That leads me onto my third point. The value or equity you have in your home.

The advantage of buying a home at the bottom of the cycle is that even if prices crash by 20 per cent at the peak of the cycle, from peak to trough, you’re still very much in the money (assuming an overall rise of 50-60 per cent – as was the case in Sydney).

For all those proud homeowners though who bought in the past few years, it’s a different story.

If you’re in stable employment, and you have a buffer, it’s really no issue. However, if you bought on the thinnest of margins, and you don’t have stable, reliable income, watching the value of your home fall can be a daunting experience.

What you don’t want to happen is have the equity value of your home fall below the value of the loan (negative equity). That’s why the more equity you can bring to the purchase of a property, the better.

Possibility of a crash

Despite economists telling me the Royal Commission could trigger a housing market collapse, it’s far from a certainty.

Independent economist, Saul Eslake, for example, describes it a “potential” “unintended consequence” of the Royal Commission.

That said, there’s some agreement that if the wrong factors do come together, we could be looking at property falls, on average, of between 10 and 20 per cent (from peak to trough). That’s not out of the question.

Capital Economics’ Paul Dales though cautions that, if that does happen, it won’t happen overnight, and is far more likely to turn into a protracted downturn.

Set to get worse before it gets better

I can’t tell you if the property market is going to get a lot uglier for home owners. I don’t know that. Nor does anyone else.

There are, however, plenty of reasons to protect yourself financially for a “tightening” of conditions.

Refinancing a loan is set to get harder, you can also expect the banks to pass on more interest rate increases (independently of the Reserve Bank), and the Royal Commission still has the capacity to really shake things up.

If you’re comfortable with your home loan – great! If you’re on the edge, now is not the time for that trip to Bali I suspect.

The peace of mind you get from knowing you’ve got enough in the kitty to keep up repayments on your own slice of the great Australian dream is, amazingly, these days, quite a luxury in itself.

@DaveTaylorNews