Recent borrowers at risk of becoming ‘mortgage prisoners’

Recent homebuyers who bought at the peak of the housing market with low deposits could find it harder to switch banks in their hunt for cheaper rates, despite the mortgage refinancing boom under way in the market.

With interest rates tipped to climb higher, experts have warned a sizeable group of borrowers will struggle to meet the criteria needed to switch lenders.

The main pain point for some mortgage holders, according to brokers and analysts at investment firm Jarden, will be that they will no longer pass lenders’ stress tests for new borrowers. Falling house prices are also expected to push loan-to-valuation ratios (LVR) above the 80 per cent threshold at which new borrowers must often pay for mortgage insurance.

Research by Jarden chief economist Carlos Cacho estimates there are hundreds of thousands of these “mortgage prisoners”, adding that the trend could benefit banks by dampening home loan competition.

Cacho estimated 10 to 15 per cent of outstanding home loans could be stuck with their respective lenders, with first home buyers who bought near the peak in house prices particularly exposed to the risk.

“There’s probably $200 billion to $300 billion of mortgages which are going to face difficulties refinancing,” Cacho said.

“Realistically, most of the people who are going to face difficulties are going to be people who originated their loans in the last two years. If you got a loan five years ago, you’re probably going to be OK.”

The “mortgage prisoner” issue arises because when a customer refinances, the bank issuing the new loan must assess a borrower’s ability to service interest rates that are 3 percentage points higher than today’s rates. This means customers seeking to switch must be able to afford repayments with rates of about 7.5 per cent and 8 per cent – whereas last year the same borrowers may have been assessed on their ability to handle rates of 5 per cent to 5.5 per cent.

Falling house prices can also make it harder for people with less equity in their homes to switch banks. For example, if a mortgage’s loan-to-valuation ratio has risen above 80 per cent as a result of the housing correction, a homeowner seeking to refinance could be required to take out mortgage insurance by their new lender, at a cost of thousands of dollars.