The generally-accepted definition of mortgage stress is 30% or more of gross (pre-tax) household income going towards paying off the mortgage. This means if you have a monthly income of $10,000, mortgage stress would be a $3,000 or higher monthly payment. The likely proportion is much higher after tax.
Of course, you may have a high income and feel the effects of this percentage less as essential living costs generally remain the same across income bands, but for most Australians, spending a third or more on a home loan can often be a struggle. If you think you might be under mortgage stress, then read on to find out more about how to deal with it.
How to deal with mortgage stress
There are several things you can do yourself to ease the stress, especially if you're only just over the 30% limit.
1. Refinance your home loan
If you're not too far over the 30% benchmark, then refinancing your mortgage could be worth a look. Refinancing to a lower interest rate could lower your repayments by hundreds per month, putting thousands of dollars back in your pocket over the course of a year. However, there are usually costs associated with this as you are essentially signing up to a new home loan.
Another thing too is that you'll have to assess why you're in mortgage stress. If you or your partner have lost or changed to a lower-paying job, a new lender might determine you can't service your loan. You might have a new car loan, for example, eating into your borrowing power and budget. Being unable to refinance yet stuck with paying a high interest rate is called a 'mortgage prison'.
2. Lower your repayments
If you've been paying extra into the home loan and interest rates are falling, you could make the switch to a lower repayment. While cashflow might be tight if you're in mortgage stress, it could be good to fight the urge to lower to the minimum repayment and continue paying a little extra into the home loan if you are on a variable rate.
Keeping the repayment higher-than-minimum has a two-pronged effect: One, is that it gets you used to paying a higher amount, so if interest rates rise again you won't be affected materially - more of the repayment will just go to paying interest instead; and two, it could shave years off your home loan and lower the interest payable considerably.
3. Consider using your offset or redraw
Both offset and redraw accounts can lower interest payable. While this doesn't necessarily change repayment amounts, it could shorten the length of your loan and save thousands in interest over the years.
Similarly, if you have a pile of money in an offset or redraw, consider withdrawing it to pay off other forms of debt with higher interest rates. If you had $20,000 in the account and a $20,000 car loan, you could pay off the rest of this car loan (if it lets you pay the loan off early) and eliminate one pesky repayment from your budget. Such a move is called opportunity cost.
4. Switch to an interest-only mortgage
This will reduce your monthly repayments quite a bit, but it's only a short-term solution, as you're not paying off any principal. It could be useful if you have some short-term cash shortfalls such as being unable to work, being on maternity leave, or some other big financial hit.
Lenders generally prefer this option than falling behind on your mortgage, so it's best to get on the front foot here. Many lenders will allow you to switch to interest-only up to five years, and you might be able to extend for a further five. Be aware however that your repayments will be higher at the end because the principal has been condensed into a shorter timeframe. This is effectively 'kicking the can down the road'.
5. Examine your spending
Have a look through your bank and credit card statements to see if there's anything you can cut down on to release some money each month. Things like too many Uber Eats, TV subscriptions that you don't use anymore, cabs to work when you could walk or lots of impulse purchases all add up and could push you into the red zone.
Similarly, it could be a good opportunity to review your phone and internet plan, and your energy plan, to make sure you're getting a better deal and picking a plan more in-line with your needs. Once you've identified your bad habits or money sinks, make a budget and try to stick to it most of the time. You may be surprised at the difference.
6. Earn some more money
At the end of the day, there's only so much scrimping and adjusting around the edges you can do. The next step might be to make extra money. This might be through getting a better job, picking up a second job, your partner returning to the workforce, selling items, negotiating a pay rise, working overtime hours, or monetising a hobby such as photography. You will generally have to tell your lender that you're going to change jobs, and you might be unable to refinance if you have changed industries recently.
How much of my income should I spend on home loan repayments?
Although the general rule of thumb is no more than 30% of income, someone on a higher income might find paying this proportion out of a higher salary manageable, as long as their other expenses aren't too luxurious. If you're finding things a bit tight every month, however, then you're paying more than is comfortable or safe and you need to take action.
Many lenders use HEM - the household expenditure measure - to determine a borrower's living expenses and their borrowing power. Developed by the Melbourne Institute, HEM assesses expenditure based on the Australian Bureau of Statistics' household expenditure survey. It is calculated using the median spend on absolute basics, plus the 25th percentile spend on discretionary basis, while it excludes non-basics.
The HEM is currently $32,400 annually, and tends to underestimate expenses. Are you spending over or under this amount per year?
Identifying mortgage stress
You shouldn't just look at the 30% rule of thumb, as everyone's circumstances are different, but the symptoms of mortgage stress are broadly similar:
- You're living from payday to payday and you're struggling to pay your mortgage and other bills on time
- You've recently lost your job or have had your hours reduced
- You've had to borrow money - either from friends or family or in the form of a personal loan - to pay for regular expenses
- Your existing home loan is interest-only and you haven't got much equity, and
- Your financial situation is causing health and relationship issues.
Avoiding mortgage stress before it hits
If you're worried about falling into mortgage stress, or if you're planning to buy your first home, then it's important to take steps to prevent your repayments becoming uncomfortable.
If you already have a home loan, then trimming your budget or refinancing can help you to swerve mortgage stress. If you're about to enter into any other debt agreement, then think very carefully before accepting it because it'll add to your monthly outgoings.
If you're about to take out a home loan, then you need to be very realistic about how much you can afford. Use a borrowing calculator to work out how much you can pay each month without overstretching yourself. It's important to build in a savings plan to these calculations, too, to create a buffer.
You'll be paying a mortgage for a long time and at substantial cost, so it needs to fit you. Look at cheaper suburbs, a slightly smaller property or maybe even a different town or city. Once you've built up some equity, you can think about upsizing or moving nearer to your ideal postcode.
Don't suffer in silence - reach out
Mortgage stress isn't just financial, it can affect your sleep, your health and your relationships.
There's help out there and you should access it as soon as possible so that you stay at the “Cutting out my least favourite TV subscriptions” stage rather than the “I'm facing bankruptcy and my home loan is in default” stage.
You can reach out to your lender and in many cases work out a payment plan. Many lenders prefer you to contribute something, or work out some sort of agreement, than to fall into arrears or even default. This looks bad on not only you but them as well as recovering funds and the home is a painstaking process for all involved.
There's also the National Debt Help Hotline on 1800 007 007, for example, or The Department of Human Services' crisis and special help team, as well as Lifeline on 13 11 14 for emotional support.