What is a mortgage prisoner?

A mortgage prisoner is someone who lacks the equity or serviceability requirements to refinance their home loan. Because they aren’t able to jump ship, borrowers can find themselves trapped and drowning in a mortgage they can no longer afford. 

Many factors can lock someone up in ‘mortgage prison’, and it rarely has to do with how good a borrower they are. More often than not, it’s a problem of costly repayments, negative equity, or simply not meeting certain loan-to-value ratio requirements. 

So as more people refinance their mortgage in 2023, let’s investigate what mortgage prison means, why it happens, and how you can escape from it.

Your salary, the date you bought your property, how much you owe on your loan – all these can decide whether or not you wind up in mortgage prison.

For some people, the problem lies in not being able to meet a new lender’s serviceability requirements. If your employment situation has changed and your income has taken a hit, you’ll have a harder time convincing lenders to take you on board.

The same applies if your living expenses have increased. Banks want to see if you can make your monthly repayments and have enough left over to cover your day-to-day purchases. If your cost of living has gone up substantially, banks will flag this.

The other way you can find yourself in mortgage prison has to do with how much equity you have in your home. This is the current value of your property minus the amount you still owe on your mortgage.

For example, if you took out a loan of $400,000 to purchase a $500,000 home, you’ll have $100,000 in positive equity at that point in time. That translates to a loan-to-value ratio of 20%.

Someone might find themselves with an insufficient amount of equity for a number of reasons, but the most common are:

• You bought at the top of the property cycle and prices have since dropped
  
• You overpaid for your home and haven’t had enough time to build up enough equity
  
• You’re bought with a low deposit
  

Whatever the reason, if your LVR is above 80% your application to refinance will be subjected to a lot more scrutiny than others. You’ll be considered a risky borrower and will likely have to fork out thousands of dollars for Lenders Mortgage Insurance.

Things get even more difficult if you have negative equity, which is when you owe the bank more than what your property is currently worth. If this is the case, the maximum amount a bank might be willing to lend you could be lower than your current mortgage.

There are a number of paths that can lead you to mortgage prison, and oftentimes the only thing connecting them is bad luck. Below are just a few examples of how you might find yourself trapped with a loan that isn’t right for you.

Example 1

Alex bought a property just as prices had reached their peak, and the subsequent dip in values has wiped out a good chunk of equity he previously had in his home. This has pushed his LVR to below 80%. When he tries to refinance, the lender informs him that he cannot do so unless he takes out Lenders Mortgage Insurance.

Example 2

After a year with her current lender, Michelle realises there are more competitive offers elsewhere and decides to refinance. Unfortunately, this comes at a time when the cost of living has skyrocketed. The lender Michelle has applied with takes a look at her expenses and deems them too high. Her application is rejected.

Example 3

Andy lost his job and has to take out a lower-paying job to make ends meet. To help ease his financial burden, he decides to refinance to a cheaper home loan. Even though he has not missed any repayments so far, the lender is sceptical of his ability to make them in the future. His application is rejected.

A combination of factors has created a housing market uniquely primed to trap borrowers in mortgage prison.

Firstly, the elephant in the room: the Reserve Bank of Australia. In an effort to control inflation, the RBA has unleashed an unprecedented round of rate hikes, which have increased the interest payments for borrowers on variable-rate home loans. 

This also has an impact on serviceability buffers, since lenders will have to test prospective borrowers at higher thresholds. 

Because it’s harder to finance a home loan, many buyers have pulled out of the market entirely. Meanwhile, sellers find themselves unable to offload costly properties or must compromise on price more than usual to sell. As a result, property prices have slid downhill all over the country in the last twelve months, dragging down the equity of recent home buyers. 

There’s also the matter of fixed rates. Many homeowners bought in during the 2020 - 2021 property boom when fixed interest rates were at all-time lows. Now, they’re rolling off their terms in a drastically different rate environment, with some mortgages spiking upwards of 4 - 5% in interest. This adds a cost burden of hundreds of dollars a month, which some buyers may not have properly prepared for given the RBA had previously stated rates wouldn’t rise until 2024.

Indeed, interest rates have risen so much that Roy Morgan reports 1 in 4 Australian mortgage holders could be ‘at risk’ of severe mortgage stress by March 2023. 

We likely haven’t seen the end of rate hikes for this year yet, either, so among inflation and cooler housing values, 2023 may have to grapple with a growing population of mortgage prisoners.

While mortgage prison might seem like a terrifying prospect, it’s far from hopeless. 

Firstly, it’s vital to try and stay out of it in the first place. Before you buy, consider saving for at least a 20% deposit or higher. This way, you start out your home loan journey with more equity in your pocket. 

Secondly, be choosy about where you buy. Aim for suburbs with some key signs of future capital growth; while future market conditions are never guaranteed, housing prices have historically always risen, so it’s about reading the landscape and planning accordingly.

However, if the worst has happened and you find yourself unable to leave your current lender, here are some strategies that could help jailbreak your mortgage.

• Negotiate with your current lender. If you’re drowning in costly mortgage repayments, reach out to your lender and ask for a lower variable interest rate if you can. Alternatively, if the fees have added up, ask if you can drop down to a more basic home loan package. 
  
• Pay down more of your principal. Many home loans allow free extra repayments with a redraw facility, so if you can, pay off your principal to increase your equity. If you need the funds later, dip into the redraw. 
  Cut out unnecessary expenses. Serviceability compares your expenses to your loan obligations: by reducing your lifestyle costs, you can help balance the scales again.
  
• Send for a credit check. Credit health is a major part of the loan application process, so if it’s been a while since you’ve checked your credit score, investigate it and see if you can take some steps to improve it. 
  
• Rent out your property. Many homeowners have rented out properties they’re unable to sell at the price point they want. If you can negotiate a rental income to help pay off your mortgage sooner, this can help with your serviceability while you refinance. 
  
• Consolidate your debt. Lenders must consider other forms of debt like outstanding HECS-HELP student loans and Buy Now Pay Later services when assessing your mortgage application. Where possible, consolidate and pay off your remaining debts. 
  
• Boost your property’s value. Little renovations or even installing green features like solar panels can add to your property’s value, which may offset some of your capital losses. It’s important not to sink too many funds into upgrades, however, so consult a financial advisor. 
  
• Compare refinance options. Refinancing can sometimes be as involved as getting the initial home loan. Do your due diligence and compare refinancing options to understand where you stand in the market. 
  
• Talk to a financial advisor. Don’t suffer in silence! Enlist the aid of a qualified financial advisor to go over the books with you and work out a customised solution.
  
• Apply for financial hardship. Thanks to recent changes in how lenders report missed repayments, it’s easier and wiser to apply for financial hardship than ever before (without it impacting your credit score). Discuss with your lender what options are available.
  
• Worst comes to worst, sell. While it can be heartbreaking to part with a property you’re not ready to leave just yet, sometimes needs must, and there are ways to boost your chances of a successful sale in a falling market. 
  

Compare refinance home loans below.