Younger Australian homebuyers are increasingly at risk of being trapped in “mortgage prison”, as higher interest rates and falling property prices make it harder to refinance with a rival lender.
The warning comes as interest rates reach an 18-year high and households look for ways to reduce the cost of their biggest expense. Refinancing is often the quickest route to a cheaper home loan, but recent figures suggest many borrowers may no longer meet the lending criteria required to switch banks.
Data from credit bureau Equifax showed that refinancing with a different lender fell by 8.8% in the year to September. The decline was most pronounced among younger borrowers, with refinancing demand among people aged between 26 and 35 dropping by 14.2%.
By contrast, refinancing demand rose slightly among people aged between 56 and 60 and those aged over 60.
Moses Samaha, Equifax Australia’s executive general manager, said older homeowners were generally better placed to negotiate or refinance because they had built up more equity and reduced their loan balances.
“Older homeowners with higher equity and lower loan balances retain the flexibility to negotiate or refinance, mitigating some of the pressure from successive rate hikes,” he said. “Younger Australians, on the other hand, are facing a tougher proposition.”
Why younger borrowers are being locked in
Banks are required to assess whether prospective borrowers could cope with higher repayments, including customers seeking to refinance from another lender. They apply a serviceability buffer of three percentage points to the current home-loan rate.
With rates now higher, that can mean testing whether a borrower could afford repayments at a rate of about 9.5%. Recent first-time buyers are particularly exposed because many have taken on substantial debt to enter the property market.
Falling house prices create a second obstacle. People who have owned their homes for many years are more likely to have built up substantial gains, even after a recent decline. Newer buyers have had less time to benefit from rising prices and have often borrowed a large share of their property’s value.
That can push up a borrower’s loan-to-valuation ratio, another measure considered by banks. In some cases, those attempting to change lenders may also face the additional cost of mortgage insurance.
Mortgage brokers have warned that borrowers can become effectively stuck with their existing bank when they no longer pass the affordability checks applied by competitors. The risk is particularly acute where households are facing both higher repayments and a reduction in the value of their home.
Some borrowers are able to avoid the restrictions. Banks can grant exemptions from serviceability rules in certain circumstances, and Canstar reported in September that exemptions accounted for a record 5.8% of all new loans settled during the quarter.
However, the combination of rising rates and falling property prices is continuing to make refinancing difficult for financially stretched first-time buyers. The risk of mortgage prison is expected to remain until the Reserve Bank decides that interest rates can begin to fall.
