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Sunday, October 28, 2007

Mortgage Rates Stress

This is on top of any movements by the Reserve Bank of Australia, which again will have a flow on effect and raise mortgage rates - already at an 11-year high - as early as November.

In some states property prices have also fallen and as a result low-income homeowners with high-risk loans could be left owing the bank more than their property is worth, forcing them into bankruptcy.

The credit crisis emerged last month in the US sub-prime mortgage market, which lends to people with poor credit ratings who cannot get loans from the big institutions, and has since spread globally, Increases in mortgage rates will affect customers of many banks, because they source about a third of their funding from the global money markets.

After three years of low mortgage rates, those who had taken out low-doc loans and mortgages for more than the price of the property would be hit hardest. As house prices soared during the boom, those who could not save a deposit, had a poor credit history or did not have documentation of their income used these types of loans to get into the market.

Low-doc borrowers are finding it tough to meet their mortgage commitments due to the increase in mortgage rates, with the number of households in arrears by 60 days about double that of those with loans that have normal mortgage rates.

Further mortgage rate increases as a consequence of RBA increases could force tens of thousands of people into banas a result of rising mortgage rates often occurs in discrete areas with the result that if numerous owners are forced to sell, the increase in supply drives prices down in that suburb, leaving people with negative equity.

These scenarios are not often considered buy borrowers and particulalry first home buyers when they are entering the property market. The carrot of a 100% + mortgage loan and the rose-tinted view that property prices will only ever increase creates a false sense of security for first home buyers. If they are purchasing in a new sub-division with a house and land package then they not only need to consider mortgage rates but also the geographical location of the property being purchased and other planned subdivisions coming on near or adjoining their selected subdivision. Mortgage rates obviously impact on cash flow but this problem can be compounded by the fact that the property value has decreased since the inception of the mortgage.

In Australia mortgages are in effect guarantedd by the borrower. In the event that a borrow defaults, say because of high mortgage rates, then unless that default is rectified, the lender can commecne action to sell the property and recover the debt form the sale proceeds. If the situation outlined above, the borrower has take a 95% or more loan and the value of the security porperty has subsequently fallen then it is unlikely that the lender will recover the money owing to it. The shortfall or outstanding amount can be recovered by the lender and this is why we are seeing an increase in the number of bankruptcy actions before the court. Obviously, a borrower who cannot make loan repayments because of high mortgage rates is not fgoing to be in a position to repay any outstanding amount that remains after the sale of the property.

By all means consider current mortgage rates and anticpate your position in the event that mortgage rates do increase but also think carefully about how much you are borrowing against the value of the property, where is it located and the impact on your property value of any new subdivisions planned for the area.

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