Mortgage stress: what are the main causes of mortgage arrears and defaults?

It’s the great Australian dream to buy a home or property of your own, but what happens if you start missing home loan repayments and slide into the red? Canstar reports.

Under Australia’s responsible lending laws, lenders have a responsibility to only give out a loan if it’s suitable for a borrower. Factors such as your credit score are considered when you are assessed for a home loan, and can influence whether your application is approved, as well as what deals you are offered, including the interest rate. Even so, circumstances can change, sometimes unexpectedly, and you might find yourself in the stressful situation of not being able to make your mortgage repayments.

What is mortgage stress?

Mortgage stress happens when you’re struggling to pay your bills and also cover your home loan repayments. A commonly used benchmark, including by the Australian Bureau of Statistics (ABS), is that mortgage stress can happen when a household with a relatively low income also spends 30% or more of its pre-tax income on making home loan repayments. Another metric is that you’re in housing stress if your income is less than your overall expenses (Digital Finance Analytics); while Roy Morgan calculates mortgage stress “using a complex formula”, considering costs, mortgage repayments and account household income.

What is a mortgage default?

A mortgage default is when you fall behind in making your mortgage repayments. According to Moneysmart, a lender can send you a default notice on the day a repayment becomes overdue, or they may wait until your repayment is 90 days or more overdue. With a default notice, you’ll get 30 days to make the payments – including both what’s outstanding and any regular repayments owed. You’ll also be able to apply for a hardship variation, Moneysmart says.

What are the main cases of mortgage arrears and defaults in Australia?

The Reserve Bank of Australia describes common reasons Australians can fall into arrears and default on a mortgage, such as:

ill health
losing your job
divorce or separation
weak house prices
large increases in interest rates
borrowing more than you can really afford

What is the double-trigger hypothesis?

Findings from a recent RBA research paper support a theory, known as the ‘double-trigger’ hypothesis, that mortgage defaults need two ‘triggers’ – a reduction in borrowers’ ability to repay their mortgage (such as from lower income), and negative equity. Consistent with international evidence, the findings outlined: “Both triggers are needed. With only the first trigger, the borrower may enter arrears but can profitably sell their house to avoid foreclosure. With only the second trigger, the borrower can continue to repay their mortgage.”

How can I tell if I’m experiencing mortgage stress?

Here is a quick test you can take to consider if you might be experiencing mortgage stress. As a homeowner, do you:

spend more than 30% of your pre-tax salary on your home loan?
pay interest-only on your home loan?
struggle to find money for utility bills?
pay those bills with your credit cards?
pay only the minimum due on your credit cards?
regret buying that fancy car with the balloon payment at the end of the car loan or lease?

If you answered ‘yes’ to the majority of these questions, mortgage stress could be an issue for you and it might be time to look at strategies to help ease that burden. Taking control of your finances now could save you heartache in the long run.

How can I avoid mortgage stress?

There are some steps you can take to reduce your likelihood of experiencing mortgage stress and defaulting on your mortgage, including reducing your loan-to-value ratio (LVR), maintaining a consistent income, investing well, minimising the total cost of your home loan and budgeting.

1. Reducing your loan-to-value ratio (LVR)

Ensuring you don’t take out a home loan with a high LVR, and purchasing a property with a reasonable deposit, may help reduce your risk of mortgage stress. If you borrow money for a home loan and have a high LVR, you’ll generally be considered to be higher risk by most lenders, and could put yourself at higher risk of going into negative equity. You may have fewer options for a loan, too. Plus, lenders often require borrowers with a high LVR (with some first home buyers as an exception) to pay lenders mortgage insurance as an extra cost.

Compare Home Loans for First Home Buyers

2. Maintaining your income

Maintaining consistency in your income over time could also help reduce your risk of defaulting on your mortgage. The RBA’s mortgage defaults paper found ‘ability-to-pay’ factors contributed to borrowers falling into arrears. Unemployment, as well as reduced income, were found to be contributing factors, with borrowers who have ‘volatile’ incomes at greater risk of defaulting on mortgages. You may find that a second job, or even a side hustle, could help if you have job insecurity. You may also want to consider income protection insurance.

3. Investing well in property

Different factors can influence the value of your property investment in the longer term. The RBA report found the area where property was purchased correlated with the likelihood of experiencing mortgage default and foreclosure. Low regional housing turnover rates, which may be associated with difficult selling conditions, increased the probability of home loan foreclosure.

If you buy well – investing in property that has solid fundamentals for capital growth and pay a reasonable price based on market factors – you’ll be better placed to benefit from capital gains. You may find it’s a good idea to organise a property valuation before you buy too. Making a smart property investment could help reduce your risk of going into negative equity longer term. With regular principal and interest repayments and capital gains, your equity should increase over time.

4. Seeking out a competitive home loan deal

Whether you are a first home buyer or an investor, getting a competitive home loan can help to reduce the total cost of your home loan longer term. The RBA paper found that higher loan repayments increased the odds of borrowers falling into arrears. By negotiating a competitive interest rate with your bank or lender, and considering home loan offers such as cashback deals if you refinance, you might be able to lower the total amount you need to pay back.

Compare Refinance Home Loans

5. Budgeting

Budgeting could help you to cut back in other areas of your life to save money and be able to repay your home loan. Are there any extra expenses you are paying for now that you could cut out? You can use Canstar’s home loan repayments calculator to think ahead in managing your mortgage, and we have additional finance calculators, including for budgeting and saving, that you might find helpful.

What can I do if I am in mortgage stress?

If you are in mortgage stress, you can speak to your lender, and consider steps such as reducing your repayments, accessing an offset account or redraw facility if you have one, swapping to interest-only repayments temporarily, restructuring your loan or even refinancing with a different lender.

You may also find it helpful to speak to a financial counsellor to discuss your situation. Free financial counselling is available from the National Debt Helpline on 1800 007 007.

Where can I get help if I’m experiencing mortgage stress?

Perhaps the most important thing to do if you are in mortgage stress is to talk to your lender. If you tell your lender you are having trouble meeting your monthly repayments, they are obligated by law to assist you in setting up an affordable repayment plan. If your lender is already taking legal action, consider getting legal advice so that you know what your options are. You can get free legal advice from services listed by Moneysmart.

What financial support is available from banks during COVID-19?

During the COVID-19 pandemic, banks have been offering support packages to customers affected by lockdowns, such as repayment deferrals, refunds of merchant terminal fees and home loan support, according to the Australian Banking Association (ABA).The ABA is encouraging anyone experiencing financial hardship or difficulty due to COVID-19 to contact their bank as soon as possible to discuss options for assistance.