What is a mortgage stress test?

A mortgage stress test assesses your ability to afford your mortgage by comparing your income and expenses with different repayment scenarios. It helps you make informed decisions regarding your mortgage payments.

In Australia, the threshold for mortgage stress applies when more than 30% of pre-tax income goes to mortgage payments. If you are struggling to pay off your mortgage on top of everything else you need to spend money on, you may be suffering from, or are on the verge of, mortgage stress.

Mortgage stress can feel overwhelming for those suffering from it. Still, you can take several steps before you enter the property market as a first-time buyer to be better prepared for all eventualities, and one of these is to do a mortgage stress test.

Who should do a mortgage stress test?

Anyone wanting to buy a house should do a mortgage stress test. This step is important because the test evaluates your ability to manage mortgage payments under different scenarios, such as a rise in interest rates or a change in personal circumstances.

From a homeowner’s perspective, mortgage stress can apply to anyone worried about being able to pay off their mortgage — especially those who may have already missed a payment or two.

From a lender’s perspective, mortgage stress applies to anyone paying more than 30% of their pre-tax income on their mortgage. So, if you earn $10,000 pre-tax a month and your monthly repayments are $3000 or more, you could already be in mortgage stress.

How to do a mortgage stress test

Doing a mortgage stress test is fairly straightforward. You can use basic math to figure out your mortgage stress percentage, or you can use a mortgage stress calculator.

Calculating mortgage stress percentage on your own

You can calculate your mortgage stress percentage with some simple math:

Divide your monthly mortgage repayment by your household’s gross monthly income.
Multiply the result by 100 to express it as a percentage.

For example, if your monthly repayment is $2000, and your monthly pre-tax income is $6000:

$2,000 ÷ $6,000 = 0.33
0.33 x 100 = 33.33%

So, your mortgage stress level would be 33.33%, which is above the threshold.

Using a mortgage stress calculator

There are many mortgage stress calculators online that you can try, and they’re all simple to use. Just key in your income and monthly repayments, and you’ll get an indication of what level, if any, of mortgage stress you are in.

If you aren’t an existing homeowner, you can use a mortgage repayment calculator to estimate potential monthly mortgage costs based on how much you can afford to borrow. Then, key that amount into the mortgage stress calculator.

After you get your result, be careful not to interpret it too literally. Mortgage stress calculators only approximate your current stress level. They rarely estimate your potential stress level if your situation changes — such as a fall in your individual or joint income or a rise in interest rates. These changes are factored in by lenders, however.

» MORE: How to calculate mortgage repayments

Loan serviceability expectations

Lenders for new mortgages are now required to factor in potential interest rate changes before issuing loans. In October 2021, following a period of very low rates in which banks lent large amounts for home loans, the Australian Prudential Regulation Authority (APRA) introduced new loan serviceability expectations.

In a letter to all authorised deposit-taking institutions (lenders), APRA said they needed to assess the ability of new borrowers to meet their loan repayments at an interest rate of at least three percentage points above the rate of the loan they were seeking. At that time, cash rates were at historical lows and were effectively at zero. Since then, there have been several rate rises, leaving the cash rate at 4.35% (at the time of writing).

In practical terms, a lender’s stress test evaluates your income against the highest possible rate you could find yourself tied to. So, if you can get a loan today with a standard variable rate of 6.24%, the stress test will evaluate your ability to pay your mortgage if rates rise to 9.24%.

For example, if you borrowed $600,000 for a 20-year mortgage at a standard variable rate of 6.24%, your monthly principal and interest repayments would be $4382. Therefore, under the terms of the APRA guidelines, you would need to be able to service a mortgage if the rate was 9.24%, in which case the repayments would jump to $5491 a month.

That means, to avoid meeting the definition of being in mortgage stress, your household pre-tax income would need to be at least $18,303 a month so that only 30% goes towards paying off the mortgage.

Stress testing your budget

Aside from the standard lender’s stress test, you may want to stress-test your budget against current home loans before applying for your first mortgage. The results will help you see how well you could cope financially under adverse circumstances.

As a first-time home buyer, you may want to engage a mortgage broker who can present you with various scenarios in which you could stretch your budget. They can guide what provisions you may need to make to not end up in mortgage stress. The most extreme of these would be losing your job and, therefore, your income. In that case, you would need to contemplate taking out income protection insurance of some description to cover the period in which you couldn’t work because of injury or permanent disability.

A mortgage broker can also help you analyse your current investments and monthly commitments. They can also advise you on the savings you would ideally have in reserve to cope with another potentially significant financial upheaval, such as a medical emergency or major car repairs.

If you plan for the worst, you’re more likely to avoid mortgage stress down the track.

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What is mortgage stress?

Mortgage stress means a disproportionate amount of income goes to mortgage repayments. Currently, 1.63 million Australians — 31.4% of mortgage holders — risk mortgage stress.

Alan Hartstein