Loophole that will allow borrowers to escape mortgage prison following RBA rate announcement

“Parole denied”. That was the message from the RBA at its December rates announcement.

The central bank’s decision to leave rates on hold yet again was grim news for the thousands of inmates in mortgage prison.

If you haven’t heard the term, ‘mortgage prison’ is where a borrower is stuck paying more interest than they need to be on a home loan, because new lenders won’t accept them as a customer.

You see, the serviceability buffer of 3 per cent, introduced by the Australian Prudential Regulation Authority (APRA) to guard borrowers and banks against interest rate rises, means you need to prove you can make loan payments at a much higher rate than you already are, in order to refinance to a loan with a rate that’s less than your current deal.

Say you’re paying 7 per cent interest on a $500,000 loan and spot a lender offering 6 per cent, you could save yourself $5000 a year by switching to that deal.

Michele Bullock and the RBA left rates on hold again in December. John Feder/The Australian.

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Unfortunately, the 3 per cent buffer means you need to prove you can actually pay $10,000 a year more than you are now, in order to access that discount.

It’s pretty hard to take. Mortgage prison is not as fair as real prison. You can be locked up in mortgage prison because you might default. That would be like being sent to real jail because there was a chance you “might” commit an armed holdup.

Canstar data insights director Sally Tindall said mortgage prison often takes people by surprise.

“A borrower who has been fastidiously paying down their debt might be shocked to find themselves shackled to their lender, but if you look back over the last few years, you can see how easily it can happen,” Ms Tindall said.

“If an owner-occupier took out a $600,000 variable rate mortgage three years ago, the bank would have diligently stress tested their finances to make sure they could still meet those repayments if rates rose by 3.0 percentage points. However, rates were at near record lows at this point.

Canstar data insights director Sally Tindall said mortgage prison can often take people by surprise. Picture: Tim Hunter.

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“Just two years later … their mortgage repayments on that $600,000 debt will have blown out from an estimated $2,399 a month to a budget-crippling $3,884 – a jump of 62 per cent.

“Refinancing (could help them save), if it wasn’t for the fact their new bank needs to add a 3 per cent buffer on to the rate they are applying for, which in many cases will take the stress test to a rate of over 9 per cent – a hurdle that is too high for many borrowers to clear.

“Re-testing refinancers seems harsh and a little bit silly. If you’ve already got the loan, why stress test these borrowers again?”

How do I escape mortgage prison?

Many borrowers have been waiting for rate relief from the RBA to either pay less on their current loan or enable them to switch to a better deal, but they may be unaware there is a loophole in place allowing banks to do what they really want to do … lend people money.

“APRA has said banks continue to have the ‘discretion to make exceptions on a case-by-case basis where it is prudent to do so’,” Ms Tindall said. “Last year, Westpac, CBA and NAB announced they would (stress test refinancer) loan applications at a buffer as low as 1 per cent in some cases, provided the borrower met certain other criteria.

“While this decision flies in the face of APRA’s buffer, the banks have the ability to process these loans as ‘exceptions to serviceability’, something the regulator is happy to wear, provided these loans don’t become the norm and that there are prudent checks and balances.”

So getting a better deal often comes down to convincing a bank you aren’t risky enough to warrant a full stress test.

“The first port of call should be a good broker,” Ms Tindall said. “Brokers have access to a panel of lenders and should be able to tell you which ones are likely to green light your application and what rates they might offer. Then you can make a balanced decision based on the options that come back.”

Ms Tindall said borrowers should also get themselves into the best financial shape possible, by cutting up credit cards, paying off other debts such as car or student loans and consider a second job to boost income.

Mortgage Choice broker James Algar said there had been a recent increase in lenders taking the “common sense approach” to the serviceability buffer for refinancers.

“There are 13 lenders on the Mortgage Choice lender panel who assess serviceability at 1 per cent,” Mr Algar said. “Most lenders will want the borrower to declare that they don’t foresee any material changes to their ability to pay their home loan, they’ll check that the borrower hasn’t incurred arrears or hardship in the last 12 months and that they haven’t missed any credit card payments.

“Having a lower serviceability buffer for borrowers looking to refinance makes sense if the borrower can comfortably make the loan repayments but don’t meet the lender’s stress test.

Mr Algar also said borrowers were often surprised to learn that borrowing capacity can differ significantly depending on which bank you are applying with.

“(If borrowers) apply for a home loan with 20 different lenders with the same financial details, their borrowing capacity will be different with almost every single lender,” he said.

“I recently helped a customer refinance who purchased his home two years ago. I received three valuations from three different lenders for the same property, one valued his home at $980,000, the other at $1.1m, and the other at $1.05m. On the lowest valuation, he couldn’t afford to refinance, and on the highest valuation, he could refinance to a lower rate and borrow additional funds to do some minor home improvements without having to pay Lenders’ Mortgage Insurance. So, it can really pay to shop around.”