Anyone who took out a mortgage prior to October last year has not a second to lose to stay safe and solvent.
Particularly if they borrowed or refinanced in the five or so years before.
The Reserve Bank of Australia (RBA)’s official interest rate activity, as it scrambles to stem the spike in consumer prices, has now added 250 basis points to most home loans.
Until October 6 last year, 250 basis points was the exact amount a loan was tested to for affordability.
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That means that your lender has only stress tested your capacity to meet repayments to the precise amount to which they have already risen.
Which makes further rate hikes – the next one of which may come in just 14 days’ time – a big problem.
Even those Aussies who have borrowed or refinanced since the tougher lending criteria came in on October 6, 2021 may only have leeway of a matter of months.
Since that date, loans have been stress tested to rises of 300 basis points.
Just two more official cash rate hikes, so 50 basis points, could also put these mortgage holders into financial distress.
What’s far worse is that, at that painful point, both groups could become trapped in ‘mortgage prison’.
The rate pain to date
Rates have risen 10 times across six months – that's 250 basis points in total. All but the first and last hikes have been doubled.
The largest lenders in the land now have advertised standard variable rates of seven per cent or nearby.
Contrast this with the situation of the past couple of years – up until April this year, in fact – when it was possible to get a best-in-market mortgage interest rate of two per cent.
It’s where people have committed to large loans at these small interest rate levels that they may now be finding themselves in trouble.
Note, the stress test, required by the Australian Prudential Regulation Authority, is designed to give you a budgetary buffer and prevent you from borrowing too much.
The problem is this affordability cushion has been blown out of the water faster than anyone imagined.
What’s more, you cannot refinance now unless you pass the new 300 basis point stress test – so the hurdle to getting approved this time is even higher than last time.
And from a higher interest rate base.
That’s where the danger of mortgage prison – being locked in an ever-more-expensive mortgage – comes in.
How you can fight the hikes
All is not lost for your loan… if you act quickly.
What is vital to realise is that the benchmark that was used in the first place – the repayment reference point on top of which the 250 or 300 basis points was added – may well be higher than it should be.
That seven per cent big bank variable rate? There are still comparable, quality loans in the low four per cent range.
So if you are currently paying up at that eye-watering level, and you refinance to one of the most competitive deals, you have the 300-basis-point extra capacity necessary to pass the stress test.
Plus you’ve proven it by paying it.
But with every decision by the RBA, your borrowing power slips away.
Research by RateCity shows that an average family with two children and a combined before-tax income of $150,000 has seen their maximum possible loan size shrink by almost $200,000 since the hike-cycle began in May, from $995,800 to $800,300.
So, if times are getting too tight but you’ve realised you are paying far over-the-odds interest, you’ve not a second to lose.
Even one more rate rise might cost you your 300 basis point buffer and therefore see you denied the refinance you need.
Which would put you in the appropriately awful sounding ‘mortgage prison’.
Once the door slams shut, there is no way out but financial hardship and, taken to the extreme, forced sale.
If you are already trapped and unable to switch to a cheaper lender, the hope and expectation is that before too long, the RBA will reverse its direction and actually start to cut rates.
But those who are still free to move – even for the next 14 days only – can turn potential mortgage prison into a mortgage present.