Why recent homebuyers will find it hard to refinance this year

With interest rates continuing to rise and many people abandoning fixed-rate mortgages, many homeowners will consider refinancing in 2023.

But a sharp rise in interest rates and falling prices could make that difficult for many borrowers.

Why do so many people want to refinance?

There are two factors that are or will be driving people to consider refinancing their mortgages.

The first is easy. Interest rates rose very sharply and mortgage repayments increased. In such an environment, some people are motivated to shop in hopes of finding a better deal.

Many Australians want to refinance their mortgage.Photo: Getty

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The second, unique to the post-pandemic period, is a much more important factor.

Nearly half of all new mortgages made in 2021 were fixed term. This was much higher than the pre-pandemic case. And the share will increase in 2020 as well.

These fixed rates are now beginning to expire.

Data from the Commonwealth Bank suggests that nearly half of outstanding fixed-rate mortgages will expire in 2023. This suggests that about a fifth of all outstanding mortgages will roll off fixed rates this year.

Its expiration will trigger homeowners to consider refinancing. Especially since many move to floating rates that are higher than those available to new borrowers.

We are already seeing these drivers in action.

External refinancing, where customers change banks, has surged over the past few years, especially among owners.

Higher mortgage payments mean it will be harder for some homeowners to refinance

But there are important forces going in the other direction. A homeowner who has rented more than 75% of his maximum capacity in the past few years may find it difficult or impossible to refinance.

When you apply for a mortgage, the bank looks at your income, expenses, and loan repayment status to see if you have enough room in your budget to pay off the loan.

The important thing is that it is evaluated not by the interest rate of the loan but by the “utility evaluation rate” which is the interest rate of the mortgage plus the “buffer rate”. [1]

This appraisal rate has risen sharply over the past 12 months and is now around 8%.

Higher mortgage interest rates mean higher monthly mortgage payments. This means that the maximum amount your bank will lend you is reduced.

And given how quickly the RBA has raised interest rates in 2022, the maximum borrowing capacity has dropped dramatically.

This can be a problem if you are looking to refinance.

Even if a few years ago you were only borrowing 80% of your maximum capacity, banks won’t lend you that much. todayThis makes it difficult to refinance.

There are several countervailing factors that can help. If you took out a standard principal and interest mortgage a few years ago, you would have paid off about 5% of your outstanding balance. This is less than the amount you need to borrow to refinance.

Similarly, wages are rising, offsetting higher mortgage costs. But spending has also increased, and in aggregate at least, spending has grown faster than wages over the past few years. [2]

This constraint on refinancing probably affects many people. Unfortunately, it is difficult to know exactly how many people are in this situation. There is not much public data on how close borrowers were to their maximum borrowing capacity when they took out loans. [3]

According to Commonwealth Bank data, only 8% to 9% of borrowers borrow at their maximum capacity. [4]

However, given the sharp decline in borrowing capacity, far More borrowers than this will be affected. Even those taking out 70% to 80% of his capacity can be affected, and that group is probably quite large.

Falling prices make it harder for some recent homebuyers to refinance

There is also a small group of people who may be tied to their existing mortgages due to falling house prices.

Home prices have been falling nationwide since last March and are now down 4.5% from their peak.

Prices are falling, which means that if you bought in early 2022, near the price peak, the ratio of your current mortgage valuation (the ratio of your mortgage balance to the current value of your home) will be lower than when you bought it. means that it is probably higher than from your mortgage. [5]

If prices drop rapidly, some homeowners may find they don’t have enough savings to refinance.

However, this group of so-called “mortgage prisoners” is much smaller than those trapped by reduced maximum borrowing capacity.

The reason is that (a) the decline so far has not been large enough to eat up most borrowers’ deposits, and (b) it is not. that Many bought near the peak, and many would have bought before the big price increase in 2021.

Westpac data confirms that. Only about 8% of outstanding loans have an LVR above 80%, and many of them are still refinanceable. [6]

Banking regulator APRA is aware of the problem, but may not be able to do much

Basically, the “mortgage prisoner” exists because credit conditions have tightened so quickly and significantly as interest rates have risen. There is not much we can do to escape that fact.

But there are things you can do with margin.

APRA believes they Examining the serviceability bufferwill publish a paper summarizing their views next month.

Lowering the buffer to 2.5 percentage points, as before October 2021, could improve margins. However, the buffer rate is a tool intended to manage loan quality and bank risk. It is not intended as a cyclical means.

Fundamentally, the issue is not a prudential policy issue, competition with consumers policy.

Potentially uncompetitive mortgage rates and tying people to products that don’t fit them make the mortgage market less competitive and hurt consumers, not banks.

To address this competitive problem, customers who cannot refinance must be able to negotiate mortgage rates with banks.

[1] Currently, its buffer ratio is 3%. Prior to October 2021, that buffer rate was 2.5%, Raised by APRAThis reflects concerns about high debt-to-income borrower risk. Also, banks have a minimum floor rate of up to 5% (that is, they will use a higher floor rate even if the mortgage interest rate and buffer are below the floor), but floor rates vary slightly from bank to bank.

[2] Measured by the Consumer Price Index and the Wage Price Index, respectively.

[3] A full valuation also needs to know what has happened to your income and expenses since inception and how much your mortgage has been paid off.

[4] look CBA FY22 Results Presentationslide 83.

[5] Unless you’re making more mortgage payments to offset the price drop.

[6] look Westpac Group’s 2010 Earnings Presentationslide 82.