Why Are More People Becoming Mortgage Prisoners?

Refinancing is a common practice in home loans. Many people choose to refinance periodically, as it allows them to secure better interest rates (new customers often receive special rate discounts) and get a substantial cashback rebate, typically around $4,000. However, recently, many borrowers are finding it increasingly difficult to refinance their existing loans, especially those with higher loan amounts. This phenomenon has been coined as "Mortgage Prisoners."

What Are Mortgage Prisoners?

With the Reserve Bank of Australia (RBA) continuously raising interest rates in recent months, market interest rates are climbing. At the same time, property values are under pressure and declining, causing many Australian homeowners to become “mortgage prisoners.” In essence, a mortgage prisoner is someone whose loan is effectively stuck with the same bank, unable to refinance to a better deal.

When refinancing, regardless of whether it's a dollar-for-dollar transfer or increasing the loan amount, the basic requirement is to pass the serviceability calculator – a loan assessment tool used by banks to determine whether your current financial situation supports the loan. The ongoing interest rate hikes and declining property values have significantly impacted borrowers' ability to meet these criteria, trapping them with their current lender.

Causes of Mortgage Prisoners

From a macroeconomic perspective, two main factors contribute to the rise of mortgage prisoners: higher assessment rates and increasing Loan-to-Value Ratios (LVR).

1. Assessment Rate

As the Reserve Bank of Australia continues to increase the cash rate, banks are forced to pass on the pressure to borrowers. The assessment rate, which is used by lenders to evaluate your loan application, has been steadily rising. The higher the assessment rate, the less you can borrow under the same financial conditions.

For instance, when interest rates were at 2%, borrowers could easily secure a loan of $800,000. However, when interest rates rise to 5%, the same borrower might only qualify for a $600,000 loan, even if their income remains unchanged. This demonstrates how interest rate hikes significantly reduce borrowing capacity.

2. Loan-to-Value Ratio (LVR)

Interest rates and property values typically move in opposite directions. During an interest rate hike cycle, property values are under pressure, causing them to fall. As property prices decrease, the LVR (Loan-to-Value Ratio) increases, particularly if borrowers have made little progress in repaying their loans.

For example, if you have an $800,000 loan on a property valued at $1 million, your LVR is 80%. But if your property’s value drops to $900,000, your LVR rises to 88%, and you’ll need to pay for Lenders Mortgage Insurance (LMI). A higher LVR also corresponds to higher interest rates, reducing your borrowing capacity.

Under the combined pressure of these two factors, many borrowers cannot pass the bank’s loan test, even though their financial situation may be the same, or even better, than before. As a result, they remain “trapped” with their current lender.

If you need expert guidance tailored to your financial situation, contact our mortgage brokers today! We can help you find the most competitive loan options and secure the best rates for your home loan.

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