Should you get a smaller mortgage?

With mortgage stress in Aussie households at its highest since the GFC, experts reveal whether you should be pulling back on what you owe the bank.

Just over a year ago, property experts labelled home loans as “free money”.

All that turned a corner when the cash rate moved from 0.1 per cent to 4.1 per cent in only 13 months.

According to Roy Morgan, the number of Aussies in mortgage stress is now the highest since 2008 with more than 1 million more considered ‘at risk’. Although industry insiders expect interest rates to plateau this year, those on the financial brink need to act quickly to avoid losing their homes and damaging future credit.

Mortgage stress in Aussie households is at its highest in 15 years. Picture: Newscorp- Daily Telegraph / Gaye Gerard

IDENTIFYING LOAN STRESS

Home loan “stress” is when a household spends more than 30 per cent of its income on mortgage repayments. Kate Browne, head of research and insights at Compare Club, said savvy Aussies are doing their homework to stay out of trouble. “We’re seeing a sharp increase in people contacting us about refinancing their home loans. But they’re being rejected for refinancing because they cannot meet the serviceability requirements any longer,” she said.

While the finance industry uses the 30 per cent rule, Ms Browne said additional red flags can be early indicators of troubles.

“Other signs are when you have no savings for emergencies like car repairs, or getting sick, living payday to payday and not having any spare cash.

“We’re seeing people relying on credit, cutting back on dentist and medical appointments in order to afford loan repayments,” she said. “If you’re cutting back on essentials even before another rate rise your mortgage is unaffordable and unsustainable. These impacts go beyond the financial. Being this close to the line financially puts huge emotional and mental pressure on homeowners.”

BUILDING A BUFFER

Lenders are required by law to build a serviceability buffer of 3 per cent into each mortgage – to help homeowners manage rate rises and any other financial hiccups like changing jobs, parental leave or prolonged illnesses. Ms Browne said it’s a smart borrower’s best practice to also work out their own comfortable buffer.

“The rule of 30 per cent of your household budget still holds true – but you do need to build in some wiggle room for more interest rate rises, which are likely to happen sooner rather than later,” she said.

“It’s far better to buy something smaller or in a more affordable area where you can comfortably deal with interest rate rises. It means you can borrow less and be in a better position all around.”

STRESS-FREE STEPS

Max Phelps, author of Getting Your Money $hit Together and mortgage broker at Golden Eggs, said a homeowner’s path out of financial pressure will vary, and isn’t always permanent.

“Maybe the stress is because of maternity leave, loss of job, or high childcare costs, all of which have predictable end dates,” he said.

“The first step is to make sure repayments are made, no matter what. It may be possible to renegotiate or refinance a lower repayment, but only if this is done before any repayments are missed.

Missing a loan repayment can have disastrous consequences.

“Once a repayment is missed, refinancing becomes impossible and renegotiation difficult.”

Mr Phelps added the next stage is to review your household budget and money management.

“Most people are terrible at sticking to a budget without bucketing money,” he added.

“Consider increasing income through extra hours, a second job, or taking in a lodger, which will help someone else out of the current housing crisis. More drastic steps would be moving in with friends or family, or renting a cheaper property while renting out your home. This would likely be short term until your income increases, expenses can be cut – or worst case, the property needs to be sold.”

FINDING THE RIGHT FIT

All lenders have financial hardship departments and anyone in mortgage stress should reach out, Ms Browne said.

“The worst thing anyone in this situation can do is to do nothing. If you’re struggling, the good news is there are plenty of options to explore to keep you afloat before having to consider selling your home,” she said.

However, refinancing is not a one-size-fits-all process so it pays to be transparent with your lender.

“Maybe the loan can be refinanced, or restructured to extend the loan term, consolidate other debts, or restart a 30-year term as well as lowering the interest rate. Sometimes triggering a bank valuation with the existing lender can even unlock bigger discounts,” Mr Phelps said.

FOUR SIGNS YOU NEED A SMALLER HOME LOAN

If you’re in mortgage stress, or heading towards it, consider whether downsizing your debt and home would give you more financial freedom. Here are signs it is an option:

1. You don’t use the space: If you have empty rooms or a footprint that’s too big then rightsizing your floor plan could be the right move.

2. You fear rising rates: Experts say it’s going to get worse before it gets better so a smaller home and loan could relieve some mortgage stress in months and years to come.

3. You spend a lot of time and money on upkeep: If that’s you, consider a smaller house or unit where maintenance costs are minimal.

4. You don’t need the location: Perhaps a change of job or other life stage means you don’t need to be living in the same neighbourhood. Switching to a new location could save you thousands.

Originally published as Should you get a smaller mortgage?