As the Reserve Bank makes its ninth interest rate rise in a row, homeowners are anticipating further hikes in mortgage repayments and financial counsellors are urging them to brace for mortgage stress.
What is mortgage stress?
If a homeowner puts more than 30% of pre-tax income to mortgage payments, they fall under the definition of mortgage stress.
“It means such a significant amount of overall income going to just putting a roof over your head,” says Theo Chambers, chief executive of Shore Financial.
This leaves homeowners to make “a lot of really difficult decisions”, financial counsellor Deb Shroot says. And expenses deemed crucial in the past, such as insurance, can be the first to go.
Chambers says recent homeowners made calculations on the affordability of their mortgage based on the record low interest rates during the Covid pandemic.
“People bought properties because they were told that rates would stay that low for years,” he says.
However, the RBA has been increasing interest rates since May 2022 in response to soaring inflation. The official cash rate now stands at 3.35%, its highest level since 2012. The RBA has also indicated further rate hikes will be needed in coming months to reduce inflation, which stands at 7.8% and is well clear of the bank’s 2% to 3% target.
“That’s probably the biggest wildcard,” says Tim Lawless, research director at CoreLogic. “It is the fact that interest rates have increased by a lot more, and a lot faster and earlier, than what anyone was thinking.”
Chambers added: “People probably borrowed more than they could have today.” With borrowing capacities down almost 35% from 12 months ago, “these people wouldn’t get approved today”.
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Who is at risk?
Almost one-quarter of mortgage holders were at risk of mortgage stress as of December last year – and the number is only expected to get worse.
RateCity says this week’s official interest rate rise means the average borrower with a $500,000 loan is likely paying an extra $908 a month since rates started to rise last May. For a $750,000 loan, the latest rate increase means an extra $1,362 a month since May.
“We are expecting that [the rate of mortgage stress] will push higher into 2023,” Lawless says. “Partly because of higher interest rates, but also because of the cost of living.”
He expects monthly home loan payments to be a particular struggle for recent borrowers.
The risk of mortgage stress is “more confined to households who have seen some sort of change of circumstance”, Lawless says, such as a diminishment of income or loss of employment.
“That tends to be where you start to see mortgage distress becoming more apparent.”
Shroot says “the fact is that the price of everything is going up”.
“The price of food, petrol, all sorts of essential costs like energy,” she says. “So this is making it more and more difficult for people to not only pay their mortgages, but also pay their rent.”
The RBA expects more than 800,000 households will fall off fixed rates on to more expensive variable rates this year.
“That is adjusting from around a 2% mortgage rate to something closer to the mid-fives,” Lawless says. “We should expect that mortgage distress is going to become more pronounced through the year.”
However, tight labour markets and high employment rates are a safety net keeping a lid on mortgage defaults, he adds.
“Even if we might see mortgage distress picking up, I don’t think we are going to see a material blowout in mortgage defaults.”
What can borrowers do?
Reduce spending, Chambers says. “That is the objective of the RBA trying to reduce inflation” following two years of high cash flow during the Covid pandemic.
“We will need to see a lot more pullback in retail spending,” Lawless says. “Things you can actually control your spending on, like a holiday or dining out.”
But the reality is households “have probably already done that and are still feeling the pinch”.
“So for anybody in that sort of situation, the best thing to do is proactively get in touch with your lender and negotiate some forbearance,” for example temporarily extending the loan term, or going interest-only.
Shroot says the earlier homeowners seek help from lenders, the better.
“Tell them that you are concerned about rates going up, and see if they are able to help find a solution for you.”
Avoid taking on more debt to deal with repayments, she says. “It is generally a slippery slope.”
Shroot urges all homeowners to continue prioritising other expenses like council rates, utilities and bills “because they might not be so flexible”.
And she says there is some comfort in knowing a bank exercising their power to repossess a home in Australia is “not an easy process”.
“Banks don’t want to do it. So they do try and seek other ways for you to be able to keep your home.”
