What is a mortgage prison and how can you escape?

More Aussies will be stuck in a mortgage prison as rates rise and property prices fall. Effie Zahos looks at what this means and offers tips on how to escape mortgage prison.
Are you a mortgage prisoner? Unless you’ve recently tried to refinance your home loan you probably don’t even know or even care for that matter.
The thing is, being a mortgage prisoner is only really an issue if you want to leave your existing lender.
The problem is that in a rising interest rate market you typically do need to leave your lender if you want to score yourself a better deal.
We know that loyalty doesn’t pay as new customers usually get a better deal than existing ones. Reserve Bank data shows homeowners with an existing mortgage pay 0.5 percentage points more than new customers.
What is a mortgage prisoner?
A mortgage prisoner typically refers to anyone with a mortgage who is unable to refinance their home loan. It has nothing to do with whether or not you’re a good borrower but rather the lack of serviceability and/or security that you may have.
Let me explain. Serviceability refers to your ability to repay your debt. To date, we’ve had seven back-to-back rate hikes that have pushed the cash rate up by 2.75 percentage points. Even if you managed to score yourself a competitive rate, lenders have to put a serviceability buffer of 3 percentage points on top of the advertised rate. If your income has changed or your expenses have increased – quite possible with the rising cost of living – you may find yourself in a situation where you simply don’t meet the new lender’s serviceability requirements.
Long story short, the lender would assess you as unable to comfortably meet your repayments, which sounds ironic given you’re probably paying a higher rate with your existing lender which is why you want to refinance in the first place!
On the security side of things, it depends on how long ago you bought your home and what has happened to property prices in your area.
If the price of your property has fallen and pushed your loan to value ratio (LVR) above the 80% mark, you could find that when you go to refinance you won’t be able to without having to pay costly Lenders Mortgage Insurance (LMI). This is an expense that no borrower wants to incur at the best of times, let alone when living costs are steep and interest rates are still rising.
CoreLogic data shows national property prices have fallen for the sixth month in a row as higher interest rates make borrowing more expensive. And many mainstream forecasters are predicting national property prices could fall by as much as 20% over the next few years.
According to CoreLogic, some suburbs have already seen price drops of over 20% over the past 12 months. The tables below show the suburbs in each capital city that have experienced the strongest annual decline in house values. As you can see Sydney and Melbourne have been hardest hit. Adelaide has come out unscathed with no suburbs falling in value over the past year.
Top 5 capital city suburbs with strongest annual decline in house value
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Suburb | Current median value (Oct 22) |
12-month change in value |
---|---|---|
Sydney | ||
Narrabeen | $2,652,898 | -25.90% |
Surry Hills | $1,780,412 | -25.50% |
Beaconsfield | $1,538,804 | -25.40% |
Redfern | $1,622,270 | -24.10% |
Camperdown | $1,583,651 | -24.00% |
Melbourne | ||
Hurstbridge | $857,947 | -16.50% |
Ringwood East | $959,186 | -15.50% |
Croydon South | $834,755 | -15.10% |
Cremorne | $1,301,050 | -14.80% |
Malvern East | $2,264,616 | -14.30% |
Brisbane | ||
Fairfield | $1,040,197 | -10.50% |
Coopers Plains | $768,957 | -6.10% |
Chermside | $819,113 | -5.80% |
Moorooka | $922,708 | -4.20% |
Enoggera | $1,058,897 | -3.40% |
Perth | ||
West Perth | $898,407 | -4.50% |
Bateman | $885,613 | -3.70% |
Bull Creek | $915,256 | -3.40% |
Bicton | $1,181,625 | -3.00% |
Attadale | $1,388,990 | -2.90% |
Hobart | ||
West Moonah | $664,129 | -9.40% |
Mount Stuart | $895,735 | -7.80% |
Claremont | $556,787 | -7.80% |
Lewisham | $705,330 | -7.50% |
Sandy Bay | $1,372,108 | -6.40% |
Darwin | ||
Jingili | $527,435 | -3.20% |
Ludmilla | $707,529 | -2.40% |
Anula | $546,624 | -0.70% |
Bakewell | $489,238 | 0.80% |
Malak | $518,763 | 1.10% |
Canberra | ||
O’Connor | $1,536,340 | -11.10% |
Dickson | $1,214,229 | -10.60% |
Hackett | $1,150,778 | -10.10% |
Greenway | $620,350 | -9.60% |
Torrens | $1,081,753 | -9.40% |
Source: CoreLogic. Current median value refers to the 50th percentile of valuation estimates observed in the region. Growth rates are based on changes in the CoreLogic Home Value index, which take into account value changes across the market. Only metrics with a minimum of 20 sales observations and a low standard error on the median values have been included. Data is at October 2022.
3 ways to escape mortgage prison and cut costs
The good news is that you can still potentially escape the shackles of an expensive home loan. Here are three options.
1. Downsize your loan
The easiest option is to downsize your loan. Stop paying for features you don’t need. Call your lender and ask to speak to their mortgage variation specialist to see if there is a more suitable, cheaper alternative loan they can offer you.
For example, if you currently have a package loan switching to your lender’s cheapest offering could cut your loan repayments and provide you with some rate relief without having to refinance to a new lender.
Let’s take a look at the numbers. Moving from the average package variable rate to a basic variable rate for a $500,000 loan over 30 years could cut the interest rate by 0.14 percentage points and repayments by $43 per month while the total interest over the life of the loan could be shaved by about $15,334.
For anyone on a package variable rate with one of the big four banks then making the switch from the average big four bank package variable rate to their average basic variable rate could cut monthly repayments on the same loan size mentioned above by approximately $425 and potentially wipe more than $152,000 in interest over the 30-year loan term.
Benefits of switching to a basic loan
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Market Average | |||
---|---|---|---|
Average Variable Rate | Repayment | Total Interest Paid | |
Package Loan | 4.99% | $2,681 | $465,179 |
Basic Loan | 4.85% | $2,638 | $449,845 |
Difference | -0.14% | -$43 | -$15,334 |
Major Banks | |||
Average Variable Rate | Repayment | Total Interest Paid | |
Package Loan | 5.95% | $2,982 | $573,411 |
Basic Loan | 4.58% | $2,557 | $420,610 |
Difference | -1.37% | -$425 | -$152,801 |
Source: www.canstar.com.au – 31/10/2022. Average variable rates based on owner occupier loans on Canstar’s database, available for a loan amount of $500,000, 80% LVR and P&I repayments; excluding introductory and first home buyer only loans. Major Bank average rates based on the lowest rate available from each major bank. Repayment and interest calculations based on a $500,000 loan repaid over 30 years.
2. Refinancing may still be an option
If your property value has taken a dip and your LVR is higher than 80%, it may still be possible to refinance to a lower-cost loan but your loan options will be limited to higher LVR offers and you will likely be charged LMI.
This can be a barrier to switching and keeps borrowers in mortgage prison, however, LMI can be added to your loan meaning you don’t have to pay it upfront and the potential savings from switching could make up for it. It’s worth doing the sums on this. Keep in mind that property valuation results can differ between institutions.
3. Look for Lenders Mortgage Insurance (LMI) discounts.
If your LVR is higher than 80% and the thought of paying LMI is preventing you from refinancing, keep your eye out for LMI discounts. Discounted LMI loans are available for first home buyers but many people may not know there are also low or no-LMI loan options for those looking to refinance. Some lenders limit these to borrowers with certain professions.
Cover image source: solarseven/Shutterstock.com
This article was reviewed by our Editorial Campaigns Manager Maria Bekiaris before it was updated, as part of our fact-checking process.
The comparison rate for all home loans and loans secured against real property are based on secured credit of $150,000 and a term of 25 years.
^WARNING: This comparison rate is true only for the examples given and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate.
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The comparison rate for all home loans and loans secured against real property are based on secured credit of $150,000 and a term of 25 years.
^WARNING: This comparison rate is true only for the examples given and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate.