Westpac will introduce a more lenient stress test for borrowers seeking to refinance in order to avoid a significant increase in their monthly repayments, a situation often referred to as “mortgage prison.” Currently, 880,000 Australian homeowners who secured ultra-low, two percent fixed rate mortgages during the Covid-19 pandemic are facing a 65 percent surge in their monthly repayments when their two-year fixed-rate period ends in 2023.
Borrowers with a smaller mortgage deposit have limited options to negotiate better loan deals due to stringent financial stress tests imposed by the banking regulator. Lenders are required to assess a borrower’s ability to manage a three percentage point increase in variable mortgage rates. However, since May 2022, the Reserve Bank of Australia has raised the cash rate by 3.75 percentage points, exceeding the standard stress test imposed by the Australian Prudential Regulation Authority.
As a result, borrowers who took out a 1.92 percent, two-year fixed-rate mortgage in mid-2021 may face moving to a much higher 7.18 percent “revert” variable rate if they are unable to refinance their 25-year loan. This increase is due to the RBA cash rate reaching an 11-year high of 3.85 percent. For example, a borrower with an average $600,000 mortgage would see their monthly repayments jump by 65 percent from $2,518 to $4,163, unless the banks offer more flexibility.
Starting next week, Westpac will allow eligible customers to undergo a “modified Serviceability Assessment Rate” if they fail the standard serviceability test during mortgage refinancing. To be eligible, customers must have a credit score above 650 and a history of consistently paying off existing debts for the past 12 months.
The strict lending rules implemented by the Australian Prudential Regulation Authority have created difficulties for borrowers looking to refinance their mortgages to secure better rates. With 880,000 fixed-rate loans set to expire in 2023, many borrowers may struggle to find a favorable variable mortgage rate. The Reserve Bank’s series of rate increases has resulted in fixed-rate borrowers transitioning from a 1.92 percent rate to a 7.18 percent “revert” variable rate for a 25-year loan.
However, if borrowers can refinance, they can potentially secure a more moderate 5.72 percent variable rate. For borrowers with an average $600,000 mortgage, this could mean a $399 difference in their monthly repayments, with the potential for a 49.5 percent increase instead of 65 percent when the fixed loan period expires.
RateCity, a financial comparison group, supports Westpac’s decision and urges the Australian Prudential Regulation Authority to review the three percentage point stress test rule introduced in November 2021. While the stress test helps prevent new borrowers from accumulating excessive debts compared to their incomes, it can inadvertently trap existing borrowers in “mortgage prison.”
Many vulnerable borrowers took advantage of ultra-low fixed rates in 2021, when the RBA cash rate was at a record low of 0.1 percent and the stress test requirement was only 2.5 percent. These borrowers are now in need of rate relief to avoid financial strain. Although implementing different stress tests for new and existing borrowers may be more complex for banks, allowing those in “mortgage prison” to refinance could help prevent defaults on their loans.
RateCity’s research director, Sally Tindall, views Westpac’s decision as a strategic move to attract new customers while maintaining responsible lending practices. Tindall also calls for a reduction in the stress test, as many Australians who borrowed at capacity when interest rates were at record lows are now struggling with significantly higher repayments.
Data from the Reserve Bank of Australia indicates that around 880,000 Australians who took advantage of fixed-rate mortgages at record low interest rates will face considerable increases in interest payments when their fixed rates expire by the end of 2023. With inflation still above the RBA’s target range, NAB and ANZ are predicting further rate increases in the coming months, which could put borrowers with low fixed rates at an even greater disadvantage if they are unable to secure favorable refinancing options with their banks.
Here is an example of how a 65 percent surge in monthly repayments would look for borrowers:
– $500,000 mortgage at a 1.92 percent fixed rate in May 2021 would increase monthly repayments from $2,099 to $3,469 at a 7.18 percent “revert” variable rate.
– $600,000 mortgage at a 1.92 percent fixed rate in May 2021 would increase monthly repayments from $2,518 to $4,163 at a 7.18 percent “revert” variable rate.
RateCity’s calculations are based on the average two-year fixed rates offered by the Big Four banks in May 2021 (1.92 percent) and a default variable rate of 7.18 percent based on the Reserve Bank of Australia cash rate of 3.85 percent as of May 2023. The calculations assume a 25-year loan, except for loans above $750,000, which have a lower “revert” rate of 7.16 percent specified by NAB.
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