Here’s how to avoid the mortgage cliff in 2023

The term “Mortgage Cliff” has been coined for Aussies facing a substantial jump in their home loan repayments after their fixed-rate home loan period is coming to an end in 2023.

Many Australian households are in the process of assessing their finances in anticipation of a significant increase in interest rates that will occur when the $268 billion worth of record-low fixed-rate home loans from the major banks expire in 2023. 

There is a possibility that many Aussie households may become trapped in a mortgage prison as they navigate the home loan market.

According to Brett Sutton of Two Red Shoes Mortgage Brokers, Aussie households can use these tips to insulate themselves from mortgage prisons as well as escape them without facing foreclosure.

1. Manage debt-to-income ratios

Mr Sutton cautions that if you plan to refinance, you should be mindful of the impact additional consumer debt, such as car loans, credit cards, and store cards, can have on your borrowing capacity.

“Many major lenders have a debt-to-income ratio policy of six-times the annual income of applicants,” he said. 

“Rarely is the owner-occupied loan the problem. More often it’s the subsequent debts and loans that a mortgagor has taken out after getting their home loan that’s causing the issue.

“Mortgage holders should consider closing or reducing their unused credit cards, timing the payout of car loans with the expiration of the fixed-rate loan roll off, and temporarily halting investment spending to reduce their risk.”

During this rising interest rate environment, many lenders have reduced their lending for debt-to-income ratios above six-times and will not lend above seven-times.

2. Don’t wait until the last minute to refinance, do it early

According to Mr. Sutton, banks stress test loans at a rate of 3% above the interest rate offered as part of responsible lending policy.

“An example of this is when rates were lower you would have applied for a 2.00% p.a. mortgage with a buffer of 3% which equals a total of 5%. Now rates are 5.00% p.a., you may no longer qualify with the standard assessed buffer of 3%,” Mr Sutton said. 

“To avoid this scenario, it’s best to refinance sooner rather than later. Those concerned about an upward trend in interest rates should do what they can to maximise income prior to applying by taking additional hours at work or waiting until after the pending pay increase to apply.” 

As an indication of the number of Aussies seeking cheaper home loan rates, PEXA Insights data showed Australians refinanced at record levels in 2022, with over 378,000 refinances recorded in NSW, Victoria, Queensland and Western Australia, a 11.4% increase over the prior record year. 

As fixed interest rates expire in 2023 and banks offer enticing cashback offers and deals to lure mortgagees to switch, this trend is expected to continue. 

3. Understand how banks calculate living expenses

Banks have increased their calculation of living expenses due to inflation-induced increases in cost-of-living expenses. 

“Prior to applying for refinancing, mortgage holders should consider reducing discretionary spending for 3-6 months,” Mr Sutton said. 

“Applicants should also inform their bank or broker of any items that might mitigate their living expenses such as having the private use of a company vehicle.”

4. Be aware of the bank’s age policy

As each lender has a different policy in regards to expected retirement age, Mr Sutton says it’s important to pay attention to age policies applied by banks and lenders. 

“This is particularly critical for those in owner-occupied situations where the loan term will exceed the bank’s deemed retirement age,” Mr Sutton said.  

Mortgage holders should keep this in mind as they plan for the future. Having a viable exit strategy such as downsizing can assist with managing potential pitfalls.”

In most cases, if you’re over 50 or your loan term will continue into retirement, a bank will require an exit strategy.

There are a variety of exit strategies for borrowers, including paying for a home loan with their super balance, as well as investing and earning passive income.

5. Pay attention to loan-to-value ratios

In the event the property market retracts 10%, as many economists predict, those who purchased recently with a loan-to-value ratio (LVR) of 95% will be in negative equity and unable to refinance.

There are already losses over 10% in some markets.

PEXA Chief Economist Julie Toth notes recent mortgagees have higher mortgage costs compared to older home-owners with larger mortgages. 

“With property prices receding from their recent record peaks in many suburbs, increasing numbers of mortgagees will face higher mortgage-to-valuation ratios on their home,” Ms Toth said. 

“This change in valuation ratios will materially affect the way in which affected mortgage-holders respond to rising rates, via mortgage refinancing or property resale. At its worst, this situation can push mortgage-holders into reluctant sales, negative equity, so-called ‘mortgage prison’, and/or financial stress.”

Cutting back on spending, reducing debts, avoiding payday loans, and increasing income are just some ways to potentially increase home loan serviceability.

Buying a home or looking to refinance? Pivot Funding have a broad range of lenders with some of the lowest interest rates on the market for owner occupiers.