The banking regulator has warned more borrowers are expected to default on their mortgage repayments as higher interest rates start to bite.
As of June, the Australian Prudential Regulation Authority (APRA) estimates the share of borrowers behind on their mortgage repayments reached an historic low of 0.8%.
But a lot has changed since then.
The Reserve Bank of Australia started lifting the cash rate from its all-time low of 0.1% in May, reaching 2.6% in October – a nine year high – and said it’s expected to keep rising.
Addressing a parliamentary economics committee on Tuesday, outgoing APRA Chair Wayne Byres said the regulator is devoting ‘considerable attention’ to analysing the impact of the rapid rise in interest rates.
Mr Byres said there will inevitably be pockets of stress from borrowers who find themselves overextended, and that will be exacerbated as property prices fall.
“The rate of customers who are in arrears is… still actually drifting lower, which I don’t think anyone thinks will continue any longer,” Mr Byres said.
“Certainly when we talk to the banks… they certainly think there’ll be a reversal in the trend.”
It comes just days after the RBA warned a quarter of households with a variable home loan could fall into mortgage stress if interest rates continue to rise in line with market expectations.
Borrowers most at risk of defaulting
There are three groups of borrowers who are considered more at risk of defaulting than others, according to APRA.
The first group being those who already had low loan servicing capacity when they took out their mortgage.
In 2020 and most of 2021 banks were required to ensure loan applicants could still afford their mortgage if interest rates were to increase by 2.5 percentage points. In October 2021, the buffer was increased to 3 percentage points.
For many recent borrowers with a variable home loan, that buffer is already exhausted, or soon could be, as lenders pass on the RBA rate hikes in full. Meaning homeowners that borrowed to their capacity then, will certainly be feeling the pinch now.
The second group particularly vulnerable to defaulting as interest rates rise are borrowers with high debt-to-income ratios, APRA said.
The final group the regulator is closely watching are borrowers who fixed all or most of their mortgage in recent years, when the fixed interest rate offerings from lenders were around 2%.
“Many of those will be two- and three-year fixed rate loans which will, over the next 12 months, need to be refinanced and for those people there’ll be a significant repayment shock as they have to refinance their fixed rates into higher rates,” Mr Byres said.
“The gradual increase in interest rates that variable rate borrowers have experienced will come in one hit to those fixed rate borrowers,” he added.
Before the pandemic about 15% of new home loans were fixed, by July 2021 it was around half.
Melbourne-based mortgage broker David Thurmond from Mortgage Choice said it’ll be another 12 months before the market sees the true financial impact interest rate rises will have on this cohort.
“As we roll into the new year, you’ll start to see more and more clients having issues,” Mr Thurmond told realestate.com.au.
“I’ve yet to see any clients that are talking about having to sell and normally when clients are concerned to that level I’ll start to get phone calls and I’ll start to hear more about it and I haven’t yet, which bodes well.
“Fingers crossed it’s not as bad as everyone’s predicting, but time will tell.”
Most of Mr Thurmond’s clients are based in Melbourne’s south east, where he says the average loan size is $400,000 to $600,000.
He expects some clients who fixed in 2020 or 2021 will face repayment increases of at least $500 to $700 per month when their terms expire.
More borrowers becoming trapped in their home loan
The extra kick in the guts for borrowers in all three vulnerable categories identified by APRA is they may find themselves in a so-called ‘mortgage prison’.
Generally speaking, a loan applicant’s borrowing capacity reduces by around 5% each time the cash rate increases by 0.5%.
According to PropTrack, the recent string of rate hikes has reduced an applicant’s maximum borrowing capacity by more than 20% in six months.
At the same time property prices are falling.
Homeowners facing a combination of falling equity and falling borrowing capacity may no longer meet a lenders’ stress test to refinance and secure a lower interest rate, meaning they could get stuck with their current lender.
Research by economists at Jarden forecast 20-30% of recent borrowers – or 10-15% of all borrowers – will be ‘mortgage prisoners’ by the end of the year.
Recent borrowers are particularly vulnerable given they took out loans when interest rates were at record lows. With lenders now assessing their borrowing capacity at much higher rates, they may no longer qualify for the same loan with a different lender.
Alternatively, falling property prices could push a borrower’s loan-to-value ratio below 80%, meaning they’d typically have to pay lenders mortgage insurance (LMI) if they wish to refinance.
Jarden chief economist Carlos Cacho said unfortunately, many of these exposed borrowers are likely to be recent first-home buyers.
“We expect some of these first-home buyers, particularly those who entered the market near the peak and with low deposits, i.e. FHLDS [First Home Loan Deposit Scheme] borrowers with 5% deposits, will be most at risk of becoming mortgage prisoners,” Mr Cacho said.
What to do if you’re at risk of getting stuck in ‘mortgage prison’
The worst thing a borrower can do if they’re at risk of getting trapped in ‘mortgage prison’ is nothing, Mr Thurmond said.
Borrowers who find themselves in this situation should get on top of it early, he said, to avoid defaulting on their mortgage.
“For those clients that would potentially be in a mortgage prison, they’ve got the ability to renegotiate their rate with their existing lender,” Mr Thurmond said.
“I think the biggest issue that clients would have is that they put their head in the sand and pretend like there wasn’t an issue.
“Speak to your broker or speak to your bank to either potentially get a lower interest rate on your loan, or go into some kind of a payment arrangement – potentially a repayment holiday going interest only for a period of time.
“Do whatever you can now to try and prevent that ‘oh-no’ situation down the track.”
Source: REA website
