Signs of Mortgage Stress

Mortgage stress is the term economists and property experts use when a household struggles to meet its mortgage repayments.

Property economist and principal at Property Resolutions, Mark Wist, says that, in his view, there are two types of mortgage stress: one conventional, and one psychosomatic.

“Conventionally, mortgage stress happens when interest repayment obligations consume a more than comfortable portion of a household budget,” Wist says.

“The threshold is often considered to be around 30%-35% of gross income, above which concern builds as other household financial obligations and hard costs begin to be affected.”

While any mortgagor paying more than 35% of their gross household income could be considered to be in mortgage stress, there is no official definition, Wist explains, due to the many contributing factors.

“For example, if the mortgagor had the capacity to increase income at will, that stress could be alleviated. Similarly, if the mortgagor is ahead on payments, there may be a buffer which can be drawn down for a period of time to offset increased interest obligations.”

Meanwhile, the psychosomatic response that Wist refers to is the fear of the impact that unknown interest rate increases might have on the household budget.

This fear can prompt a household to reduce spending in anticipation of increased mortgage interest payments–which “when considered at the aggregate economic level, can impact GDP and the general demands for goods and services”.

“This underlines why the Reserve Bank increases interest rates–to slow the speed of price increases in the economy by limiting the capacity of consumers to spend,” Wist says.

There are numerous tools available online that can help you understand whether you are in mortgage stress by calculating what percentage of your income is going towards your mortgage repayments. This is known as your mortgage-to-income ratio.

Keep in mind there are additional significant costs associated with owning property–such as repairs, maintenance and dwelling insurance–which also need to be considered.

Once your mortgage-to-income ratio is calculated, it’s easy to decipher where you stand in terms of mortgage stress. If your result is less than 20%, you are not in mortgage stress nor at risk of it in the near future.

Spending between 20-30% of your income on repayments would put you at risk of entering mortgage stress if interest rates were to rise further, or if your financial situation were to change, such as if you lost a job or other stream of income.

If you are spending 30% or more of your income on mortgage repayments, then you are already in mortgage stress.

“Above that 30-35% threshold, the stress is actual, but not everyone will experience it in the same way,” Wist reiterates.

While it’s easy to use a quantitative figure to define mortgage stress, there are also some non-numerical measurements that may show you’re experiencing mortgage stress–even if you don’t necessarily fall in the more than 30% income-to-mortgage ratio.

These signs include no longer having the funds to afford luxuries, such as dining out, going to the cinemas, or ordering take away. It can also include withdrawing from social activities that cost a fee, whether that’s activities of your own or of your dependents.

Another sign can be when you’re in a situation where you are living paycheck to paycheck, and find unable to budget for certain unexpected expenses–such as a medical bill or car service. Instead, you’re reliant on asking friends and family for assistance, using credit cards, or taking out personal loans from the bank.

As Wist explains it, the issue with mortgage payments is that they are neither optional nor discretionary: you cannot avoid them, and you do not choose how much to pay below a minimum.

“In contrast, one can control–at least to some degree–how much is spent on food, energy, entertainment, etc,” Wist says.

“The mortgage payment is therefore often considered the cornerstone of the household budget around which other obligations must fit.”

This means mortgage stress can occur for myriad reasons, including personal circumstances such as a loss of job impacting finances; an increase in spending in other areas of life, such as when having a child; or due to changes in the economy.

The reason for the growing amount of Australians experiencing mortgage stress right now largely comes down to economic turbulence.

As mentioned above, interest rates are rising exponentially due to the RBA’s recent decisions to raise the cash rate to curb the nation’s high inflation rate. But inflation is also affecting the cost of living, and is keeping wage growth at a stagnant level.

Suddenly, people are expected to pay more on their mortgage repayments, are required to pay more for other living expenses as the CPI increases as well, and are not seeing their wages grow in line with inflation.

In fact, the latest report from Choice found that 90% of Australians have seen their household bills and expenses increase over the past year. The nationally representative survey also found that concerns around disposable income have increased, showing that almost three in five households no longer feel that they have enough.

Alongside the current cost of living pressures, Wist believes it has to do with “the combination of FOMO and TINA”.

“FOMO – Fear Of Missing Out – drove some buyers to enter the market when they weren’t necessarily ready and that extra demand mixed with fewer listings drove up prices, while TINA (There Is No Alternative) encouraged those buyers to pay those higher prices,” Wist explains.

“This was at a time when the Reserve Bank and economists were touting interest rates remaining ‘lower for longer’.

“Turns out, with a complex interaction of latent demand driven in part by covid financial support and supply constraints, prices start increasing rapidly which has dragged interest rates up quickly, despite the ‘lower for longer’ predictions.

“Those who bought property at high prices with maximum mortgages are now facing higher interest payments given the larger-than-normal mortgages with higher interest rates–the worst of both worlds.”

Despite the dire news surrounding mortgage stress, Wist says that there are still ways to avoid or levitate mortgage stress. These include:

• Consider a fixed rate mortgage which would bring certainty to interest payment amounts;
• Ask the lender if it’s possible to switch to an interest-only contract, which would reduce the regular payments by the amount dedicated to principal repayments;
• Add an offset feature to your mortgage, which allocates positive interest to whatever extra capital is in the account to reduce the interest burden; and
• Get on the front foot with the lender: it is much better to have an honest conversation which may enable the lender to restructure payments. Once breaches start happening, the opportunity for this may have passed.