Falling home prices increase risk of negative equity and could trap first-time homebuyers in ‘mortgage prison’
Tindall said those whose equity fell below 20% would have to take out mortgage loan insurance if they chose a new lender, a cost that would erode any savings they could get from refinancing. For those with negative equity, it would be nearly impossible to switch lenders.
Tindall said other banks are forecasting lower price drops and the majority of owners who have fallen into negative equity will be able to weather the storm. She encouraged people unable to keep up with repayments to talk to their bank about a hardship policy.
Shore Financial senior credit adviser Derek Farmer already has ‘a good chunk’ of clients in Sydney who want to refinance at a lower rate, but cannot meet the higher service requirements introduced by the banks at the end from last year.
For example, he said, a customer paying 4% on their mortgage might find a lower, more affordable rate of 3%. But due to the 3% headroom, they would be assessed on their ability to handle a 6% rate and might not qualify for such a new loan.
“We call them mortgage prisoners, they’re basically stuck with their existing lenders,” he said.
As home prices fall further, it would become more difficult to refinance those who bought at or near the top of the market, Farmer said, especially those who bought with a lower down payment.
He saw it after the market boom in 2017, with some customers struggling to refinance if their loan-to-value ratio exceeded 80%. While they could still switch lenders, the added cost of lender-required mortgage insurance outweighed the potential savings of a lower rate.
Melbourne mortgage broker Will Unkles, director of 40Forty Finance, said it would generally be first-time home buyers who bought with lower deposits in the last six months most at risk of falling into equity negatives.
Although few clients experienced significant declines in their stocks the last time prices fell, the market looked set for a steeper and longer decline this time around, he added. He also urged homeowners to consider their potential reduction in equity when considering refinancing in the cooling property market, noting it was often overlooked.
Those looking to refinance should contact their existing bank first and see if they can negotiate a better rate, he said.
Tindall said anyone looking to refinance should be aware of the fees and be wary of repayment offers that might not be as attractive in the long run as just a lower rate.
She said one mistake some borrowers made was to refinance their 30-year loan. Although this would reduce their repayments, it would make them pay more interest over the term of the loan.