Top five reasons people get into mortgage stress

Mortgage stress is never far from the news in Australia.

With years of historically low-interest rates and a booming property market, home ownership became within the reach of millions.

But the flipside of realising ‘the great Australian dream‘ of home ownership is suffering financial stress so severe that you can risk losing your home.

The reality is now sinking in for millions of mortgage holders after last week’s 50 basis-points interest rate rise.

Current data from the Australian Prudential Regulation Authority (APRA) shows that 280,000 Australians are most at risk from rising rates having borrowed six or more times their income and/or having loan-to-value ratios of more than 90 per cent.

This is out of one million loans taken out in the past two years, which the Reserve Bank of Australia (RBA) thinks are most at risk of tipping into mortgage stress with multiple rate rises.

The RBA estimates that a 200-basis-point increase in interest rates from current levels would lower real housing prices by around 15 per cent over a two-year period.

RBA data showed that the cost of living had hit a 22-year high, rising to 5.1 per cent from the year to March 2022. This has left the RBA with little choice but to hike rates multiple times this year.

The June 2022 rate increase is the largest increase in 22 years, this was the same time the Olympics were in Sydney.

There is now a whole generation of first-time borrowers who have only experienced rate decreases, not increases.

The cost of living has increased and will continue to do so. The March 2022 quarter headline inflation number of 5.1% doesn’t reflect the upcoming price hikes which are predicted to bump up inflation to 7%.

Electricity prices are set to increase on average by 18% from 1 July 2022. Groceries have continued to rise and are forecasted to increase by another 12% throughout 2022.

Fuel prices are increasing due to global events despite the recent fuel excise tax relief. HECS debt was increased by 3.9% on 1 June 2022.

The cost of renting a house has soared by up to 21.2% in Australia’s capital cities, with further rises expected as the national rental crisis deepens.

For many people, mortgage stress from these interest rate rises has become a reality. They would come under increased financial pressure and financial stress, with a greater risk of defaulting on their mortgage and losing their home.

But the reasons for mortgage stress are not quite as simple as we might think: interest rates might go up.

In this article, we look at the top five reasons people come under mortgage stress.

What exactly is mortgage stress? 

In general terms, mortgage stress occurs when a household has trouble meeting all its bills and repayments and its ability to make mortgage payments comes increasingly under pressure.

But there are more specific definitions too.

The most widely accepted definition is that mortgage stress is triggered when a household with a moderate or low income spends 30 per cent or more of its pre-tax income on home loan repayments.

Digital Finance Analytics defines mortgage stress more simply – as when homeowners spend more on repayments and other living costs than they earn.

Reason one: Borrowing more than you can afford 

‘It is common for people to think about what interest rates are now rather than what they might be in the future,” says Hamish Ferguson, a director of Vision Property and Finance.

It’s important to consider whether you could still afford mortgage repayments when conditions change – as they are.

“I recommend that you can still afford the property at 6 per cent interest rates,” Mr Ferguson said.

On the average Australian home loan, which is currently $595,000, an extra three per cent would cost over $1,000 extra for each monthly repayment, or $400,000 over the life of a 30-year loan.

Not having enough money to prepare properly for the expenses related to property ownership – such as maintenance or improvements that may happen over time – trips up homeowners. You can ask yourself the question can I really afford to buy.

Reason two: Major changes to your situation 

Lost a job, suffering ill health and experiencing major family changes can throw people into mortgage stress.

Some people purchase property with two incomes, then have one or more children, and find the loss of one full-time income as well as the increased family expenses hit hard.

“A lot of people don’t have sufficient insurance to cover their income if they fall sick or have an accident,” Mr Ferguson said.

Many people live as if their current situation won’t change and don’t build up enough of a buffer to reduce the shock of major changes.

Then when an unexpected large expense comes up they don’t have the reserves.

Life changes, and we need a financial buffer.

“‘I remember reading that around 30 per cent of people couldn’t find $3,000 if they needed it,” Mr Ferguson said.

Reason three: Interest rate increases 

Without question, changes to interest rates do cause mortgage stress but the higher repayments change the equation people have relied on.

Banks today put a minimum 3 per cent buffer on loans so they are working out affordability.

“Generally, though once people have bought, they slowly relax on their lifestyle, or their lifestyle becomes more expensive,” Mr Ferguson said.

It is important to remain mindful about our finances throughout our lives and they unlock freedom when in good shape – or cause a huge range of negative impacts when financial stress emerges and becomes chronic.

Reason four: Taking on too much debt 

Often within two years of purchasing a property, many people will upgrade their car or take out some other type of loan.

“When this happens there’s usually not sufficient preparation for other expenses or loans,” Mr Ferguson said.

“People are generally not aware of how this new debt can impact on their financial stability if a few large expenses crop up.”

Reason five: Poor communication 

It sounds obvious, but good communications usually make sense but in practice, we know they are anything but simple.

“It is surprising how often one person in the household is keeping an eye on the finances,” Mr Ferguson said.

As their financial position becomes tighter and tighter over time, that person doesn’t communicate properly with the other member/s until it is almost too late.

In committed relationships and families, it’s far better to schedule a time to talk openly about finances and not leave the burden on one person.

It’s also much healthier if one person is not taking control of all of a household’s finances either.

Sharing information and responsibility is a better strategy.

What can you do about being in mortgage stress? 

If you are obviously under mortgage stress there is one golden rule: do not ignore it.

The consequence of hoping it will go away become severe and very quickly losing your home is a realistic outcome.

First, you should speak to your lender or mortgage broker and try to make temporary arrangements. Ask for help.

The bank doesn’t want you to default on your mortgage and they can try to pull a few levers to try and make sure this won’t happen.

They are obliged to offer hardship assistance and be flexible around repayment arrangements, at least temporarily.

But you still need to make up for the shortfall.

You are likely to need financial counselling help too.

A great place to start is the National Debt Helpline on 1800 007 007 which can help you find a free (government-funded) financial counsellor in your local area.

The National Debt Helpline has several practical solutions which you can read through but it is strongly advised to make contact and work through your specific circumstances with a financial counsellor.

Can you actually afford to buy?

There is so much pressure to buy a home to enter the property market these days that renters could be forgiven for experiencing a sense of failure if they are not planning to buy.

We have recently covered how renters can avoid that sense of financial failure.

But with even the Prime Minister apparently talking up buying as a solution to renting, the pressure to buy is powerful.

When asked why there wasn’t more support for renters in the 2022 Federal budget, Scott Morrison suggested buying should be people’s objective.

‘The best way to support people renting a house is to help them buy a house,’ Mr Morrison told The Today show.

The government’s 2022 Federal budget materially supported this objective by expanding the home loan guarantee scheme, which now allows people to borrow up to 95 per cent of the value of their property without having to take out mortgage insurance.

But with so much noise apparently nudging people to buy, how can you be sure you – with your finances, personal and job situation – can actually afford to buy a home?

Is buying always best?

Hamish Ferguson says it is not always correct that buying is better for everyone.

“It is good for some people but depending on the person it is not always best.”

People have many different reasons for renting – often because they are only in a town temporarily.

Owning a home is a huge commitment, often a lifelong one and it doesn’t guarantee financial success when you sign a contract.

In fact, any big contract that involves large sums of money requiring a long-term commitment to make repayments is inherently a financial risk.

You need to be well prepared to enter such a contract and have contingency plans in case your personal situation changes.

The reality is if someone is not really ready to buy, that renting – within your means and with a savings goal – is by far a better option than scrambling to buy a home and that could instantly put you into mortgage stress.

Mortgage stress is most commonly defined as a household spending more than 30 per cent of your pre-tax income on home loan repayments.

It’s also important to remember the upsides of renting when balancing up a choice:

The benefits of renting include:

    • More freedom to travel the country and the world;
    • Less of a financial commitment, especially upfront;
    • No maintenance costs or repair bills;
    • No property taxes;
    • Greater ability to reduce living costs if your situation changes; and
    • You are likely to have more disposable income.

Peer pressure in buying property ?

There’s often a perception that the decision about buying property only comes down to the lender – and that if you can buy, you should.

It’s true that the bank greenlights your loan and your mortgage, but there’s more to it than that.

Peer pressure can make people buy property they actually are not suited to.

This is a real thing. Aussies feel peer pressured into anything from splitting bills to buying property.

Eight per cent of Australians feel they have bought property because they felt pressured.

The peer pressure could be about the location, the commitment to buy or the style of home.

For instance, you might fall for an older property because you long to renovate, but just because you can get the loan doesn’t mean you should.

“An older property needs to be considered much more carefully as it is likely that you will need to contribute a higher amount to maintenance over the life of the property than a new property,” Mr Ferguson said.

Pre-approval from a lender is good, making sure that you have disclosed an accurate estimate of your cost of living, realistic estimation of the rent that the property will generate.

‘But you also should have had a good think about major expenses that might come up over the next few years and ensure that you can afford the property taking this into consideration.”

Red flags that mean you may not be able to afford to buy

Whether you can afford to buy should be influenced by a range of factors including:

    • Your health and that of loved ones;
    • Whether your employment is stable;
    • The likelihood of increasing or losing income;
    • Having a family, schooling;
    • The stability of your other financial commitments, i.e. business ownership;
    • Changing market conditions; and
    • Additional costs above the purchase price.

In May 2022, the Reserve Bank of Australia (RBA) increased interest rates by 0.25% to 0.35%. The last time interest rates were increased was in 2007 by 0.25% to 6.75%, that is 15 years ago.

That year Steve Jobs released to the world a new product called the iPhone. A generation of new borrowers have not experienced a rate rise, only rate cuts.

The May 2022 rate increase is just the beginning, some experts are predicting a further six interest rate rises in the next two years and for consumers to take into account a doubling of interest rates.

It’s important to have enough flexibility to cope if your personal conditions change – or if market conditions keep changing.

‘I recommend that you can still afford the property at 6 per cent interest rates,” Mr Ferguson said.

On the average Australian home loan, which is currently $595,000, an extra three per cent would cost over $1,000 extra for each monthly repayment.

It would add up to nearly $400,000 extra over the course of a 30 year home loan.

Mr Ferguson says a buyer needs to take into consideration other costs such as insurance, rates and maintenance over time.

“This can depend on the area and type of property, however I would suggest that a $1.5 million property that is more than 20 years old will probably cost between $15,000 to $20,000 per annum to maintain.

“Possibly allowing 1 to 1.5% of the property value might be a reasonable level.”

What is the minimum amount of time a property investor should stick with a property?

“There are different schools of thought on this however my suggestion for clients is that a 10-year time frame as a minimum should be considered,” Mr Ferguson says.

“Generally the more regional the property being purchased, the longer the period that the property should be expected to be held.”

Mortgage stress

Despite sustained, record low interest rates, repaying a mortgage remains one of the most significant financial stressors for many Australians.

According to Moody’s Analytics, 20 percent of all Australian households are said to be under mortgage stress in Australia.

Government figures record just over a third of Australian households has a mortgage.

Considering the size of those mortgages, it’s hardly a surprise that the debt stresses us out.

ABS data shows the average mortgage across Australia is $728,500.

In NSW, it is $939,700 and in Victoria, it is $785,000.

Types of mortgage stress

At this point, it is important to define mortgage stress.

Mortgage stress is a technical term describing spending more than 30 percent of income on mortgage repayments.

That is the type of mortgage stress Moody’s refers to above.

However, another type of mortgage stress goes along with the technical definition and is real and consistently impactful on people.

This is the mental and emotional pressure of financial stress caused by being fearful, even panicking, about what might happen if your household could no longer afford the current mortgage repayments.

Why does mortgage stress happen

In short, the size of mortgage debts – for many Australians, it is the most significant loan they will ever repay.

When households are squeezed into paying over 30 percent of income towards meeting mortgage repayments at a low-interest rate, even the merest hint of a change in interest rates causes physical and emotional stress.

Don’t forget how the emotional significance of owning a home – and the fear for some of losing one – it’s a heavy burden for a lot of hardworking Australians.

As interest rates have remained low, mortgagees have become used to their repayment levels, meaning any increase in interest rates will only exacerbate mortgage stress.

“I think what is important though to realise that whilst most people are currently coping with their mortgage repayments, there is still a lot of anxiety about the future with regards to possible interest rate rises, security of employment and property prices becoming unaffordable or property prices going backwards in the future,” said Hamish Ferguson, Director of Vision Property and Finance.

How can we reduce mortgage stress

There are several successful methods of reducing mortgage stress. They include:

  1. Ensuring you are paying extra on your mortgage to build up a safety net or buffer which can be used when interest rates rise;
  2. Fix your loan if you are worried about rates going up and only have a small weekly surplus to your budget. This way, you won’t have to concern yourself with increased repayments for the time frame you have fixed for; and
  3. Review your expenses. Often when we are stressed, our level of comfort spending increases. We need to be aware of this and monitor our spending on those items that we tend to purchase when we are stressed. Eating out, TV subscriptions, buying gifts for ourselves or others, and upgrading items such as mobile phones, TVs, cars, and fashion.

How can we stop mortgage stress derailing our finances and relationships

What if we can’t eliminate our mortgage stress. How do we stop it from taking a heavy toll on our lives?

Perspective is so important. If we focus on the negative, on the difficulty of financial strain, then our relationships with money will remain challenging.

An example might be rather than saying ‘I don’t have enough money’. Instead, try to say, ‘well, at least I am still able to meet my commitments.

When it comes to relationships and money, transparency and openness are essential.

We can’t stress enough how important it is to ensure you are communicating with your partner and family and not bottling up worries and problems.

Being mindful of money goes hand in hand with good communication.

As we touched on, so much of the mortgage stress equation is about acceptable margins. Small changes – either way – in interest rates can have a significant impact.

The Australian dream holds big financial risks, so mindfulness is essential

It’s said that the American dream is upward mobility – the ultimate example being to become the US President.

The Australian dream seems more modest – home ownership, especially the good-old quarter acre block.

But arguably it comes with bigger risks than the American dream, especially for Australians in capital cities.

With interest rates at record lows and house prices surging, home ownership seems like the golden ticket for many, given the promise of appreciation that seems like it could go on forever.

But realistically, home ownership is unaffordable for an increasing number of Australian first-time home buyers, especially those in major cities on average salaries.

The fact remains ‘the Australian dream’ means many people who cannot – or barely can – afford property keep reaching for it and opening themselves up to chronic financial stress.

Who wants to give up on a dream though, right?

The problem is most pronounced in Australia’s biggest city – Sydney – where the median Sydney house price is sitting at $1,112,671, Melbourne $859,097 according to Corelogic.

To be able to afford the repayments after making a 20 per cent deposit, a Sydney household needs to earn at least $147,629 a year, 9News reported.

If that household wants to avoid living in mortgage stress – and have the relative luxury of a buffer against interest rate changes – its annual salary would need to be at least $177,155.

Mortgage stress is classified as anything above spending 30 per cent of your pre-tax income on household repayments.

According to the salary tracking website, Payscale, the average annual salary in Sydney is $76,000 – meaning the combined income even two adults earning that would fall short of avoiding financial stress.

In Victoria, it’s $70,000, it’s $71,000 in the Australian Capital Territory, while in Queensland it’s $66,000 and in Western Australia, it’s $73,000.

Because property prices are highest in New South Wales, Victoria and the ACT, anyone considering buying a home in those States, need to be on a six-figure salary to have any realistic hope of entering the property market.

9News reported 41.1 per cent of households across Australia are in financial stress despite the lower interest rate environment.

In NSW, 44.19 per cent of households were in financial stress and 37.66 per cent of households reported being in mortgage stress, and property is only getting more expensive.

Recently the ANZ bank predicted property prices in Sydney and Melbourne could surge a further 19 per cent and 16 per cent respectively before slowing in a year’s time.

So, what’s the answer? We are not saying avoid home ownership – but to be aware of what you can and cannot afford.

Mindfulness can be part of the solution to financial stress and avoiding it from taking hold.

A clarification is needed though. Mindfulness is not a solution to loan repayments that are just too high to sustain – if that is happening, we’d suggest getting honest with your bank and urgently and seeing what can be done.

But a mindful approach to money can help those who need to avoid unhealthy habits with money to maintain repayments.

Perhaps most importantly, becoming financially mindful will help people avoid entering contractual situations they really should not be in.