Anyone who took out a mortgage before October last year has not a second to lose in order to remain safe and solvent.
Especially if they’ve borrowed or refinanced in the five or so years prior.
Official rate activity from the Reserve Bank of Australia (RBA), which is struggling to contain consumer price inflation, has now increased most home loans by 250 basis points.
Until October 6 last year, 250 basis points was the exact amount at which a loan was tested for sustainability.
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That means your lender only tested your ability to make repayments to the exact amount they’ve already risen to.
That makes further interest rate hikes – the next one maybe in 14 days – a big problem.
Even those Aussies who have borrowed or refinanced since tighter lending criteria went into effect on October 6, 2021 may only have a few months’ headroom.
Since that date, credits have been stress tested with increases of 300 basis points.
Just two more official rate hikes, ie 50 basis points, could also put these mortgage holders in financial trouble.
Worse, both groups could be trapped in a “mortgage prison” at this painful point.
The pain rate to date
Interest rates have risen tenfold in six months – that’s a total of 250 basis points. All but the first and last hikes have been doubled.
The country’s largest lenders have now announced standard variable interest rates of seven percent or close.
Contrast that with the situation in recent years – up until April of this year – when it was possible to get a market mortgage rate of 2 percent.
Where people have committed to large loans at these low interest rates, they may now find themselves in trouble.
Note that the stress test, required by the Australian regulator, is designed to give you a budgetary buffer and prevent you from borrowing too much.
Trouble is, that affordability cushion blew out of the water faster than anyone imagined.
Also, you won’t be able to refinance now if you fail the new 300 basis point stress test – so the bar for approval this time is even higher than last time.
And from a higher interest basis.
This is where the danger of mortgage jail comes in – being locked into an increasingly expensive mortgage.
How to fight the hikes
All is not lost for your credit…if you act fast.
Crucially, the benchmark originally used – the redemption reference point to which the 250 or 300 basis points were added – may well be higher than it should be.
That seven percent floating rate from a major bank? There are still comparable, high-quality loans in the low four percent range.
So if you’re currently paying at this staggering level and refinancing at one of the most competitive deals, you have the 300 basis points of additional capacity needed to pass the stress test.
Besides, you got it by paying for it.
But with every RBA decision, your creditworthiness dwindles.
Research by RateCity shows that for an average family with two children and a combined pre-tax income of $150,000, their maximum loan size has shrunk by nearly $200,000 from $995,800 to $800,300 since the rate-hike cycle began in May .
So when times are getting too tight but you’ve found yourself paying interest well in excess of expectations, you don’t have a second to lose.
Even one more rate hike could cost you your 300 basis point buffer and therefore deny you the necessary refinancing.
Which would land you in the appropriately awful-sounding “mortgage jail.”
As soon as the door slams, there is no way out other than financial hardship and, in extreme cases, forced sale.
If you’re already trapped and can’t switch to a cheaper lender, the hope and expectation is that the RBA will shortly change direction and actually start cutting rates.
But anyone who is still free – even for just the next 14 days – can make a mortgage gift out of a possible mortgage jail.
Nicole Pedersen-McKinnon is the author of How to Get Mortgage-Free Like Me, available at www.nicolessmartmoney.com. Keep following Nicole Facebook, Twitter and instagram.
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