Aaron Bell
Beth Buczynski
Mortgage prison refers to a financial situation in which a homeowner cannot refinance their home loan even though doing so would save them money — essentially, they are trapped in their current mortgage.
How do you end up in mortgage prison?
There are several factors that can lead to mortgage prison.
Interest rates rise quickly
In May 2022 the Reserve Bank of Australia’s cash rate, which acts as a benchmark for lenders setting interest rates, began rising from historic lows of 0.10%. The cash rate has risen steadily since, meaning a large majority of homeowners with variable mortgages rates have had to endure rising repayments[1].
When lenders approve mortgages, they are obliged to adhere to the APRA 3% serviceability buffer[2]. This means they need to be confident that a mortgage holder can make their repayments at an interest rate that’s 3 percentage points higher than what they’re applying for. If the current rate is 6% a borrower must be able to afford a 9% rate, for example.
However, the cash rate has increased by more than 4 percentage points since 2022, and many homeowners are experiencing mortgage stress, putting them at risk of becoming mortgage prisoners.
Rising interest rates can push repayments up quickly, making it difficult to keep up. In the following example, a borrower takes out a $500,000 variable-rate loan at 2%, repaid monthly over 30 years. The table below shows how quickly repayments can be affected by rising rates.
How rising interest rates can affect repayments
| Interest rate | Monthly repayment | Increase from original repayment |
|---|---|---|
| 2% | $1,848 | |
| 3% | $2,108 | +$260 per month |
| 4% | $2,387 | +$539 per month |
| 5% | $2,684 | +$800 per month |
| 6% | $2,998 | +$1,150 per month |
| 7% | $3,327 | +$1,479 per month |
Note: This scenario doesn’t consider factors such as fees or specific home loan features but it does illustrate the impact rising rates has on repayments.
Your income is unstable
Losing your job or a large part of your regular income could be devastating if you can no longer service your mortgage.
Your property loses value
In some circumstances a homeowner could drift into mortgage prison due to a decrease in property value, which pushes your LVR higher than when you took out the loan. A decrease in value can also negatively affect your equity, making it harder to qualify for a mortgage refinance.
How many mortgage prisoners are there in Australia?
In October 2023, 1,514,000 mortgage holders (30.1%) were ‘at risk’ of mortgage stress, while 19.7 % were considered ‘extremely at risk’ according to research published by Roy Morgan[3], an independent Australian research company.
The stress kicks in once repayments become greater than 25-45% of household income, according to Roy Morgan.
How to avoid mortgage prison
Mortgage prison may be difficult to avoid if your circumstances change in a rising rate cycle but there are preventative steps you can take.
- Take out an affordable loan. Lenders operate with a 3% serviceability buffer, but you should also be aware of how thin you could be stretching your finances with your mortgage. If you can barely afford the repayments at the initial advertised rate, you may want to reconsider the loan, as any rate increases could put you at risk.
- Increase your deposit. Having a larger deposit will reduce your loan size and the total interest you pay, meaning you’ll be less affected by rate rises.
- Refinance before you reach mortgage prison. If you are quickly finding it difficult to keep up with monthly rate rises, consider refinancing to a new loan product with a lower interest rate or better terms and conditions while you still can.
How to escape mortgage prison
Talking to your lender is a good first step if you are in mortgage prison and nearly all offer financial support. Options may include pausing the interest portion of your home loan to provide some financial reprieve, though this can lead to capitalised interest.
In some circumstances, you may also be able to access your superannuation early to pay off your home loan, however this is more common for those between 55 and 60 years of age, who are permanently retired.
Depending on your property’s value, you may also be able to sell it to repay your mortgage, though you should definitely talk to your lender and seek more financial advice before you take such a drastic step.
For independent financial help you can contact the National Debt Helpline on 1800 007 007 to talk to a financial counsellor for free.
Other options include contacting The Way Forward, or MoneySmart for more free financial hardship resources.
Article Sources
-
Reserve Bank of Australia, “Cash Rate Target,” accessed June 25, 2024.
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APRA, “Update on Macroprudential Settings – December 2023,” accessed June 25, 2024.
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Roy Morgan, “Mortgage stress eased in October before the RBA raised interest rates on Melbourne Cup Day,” accessed June 25, 2024.
About the Author
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