Like any big commitment, breaking a mortgage can have serious consequences.
Depending on your interest rate and loan size, mortgages in Australia can easily cost between $1000–2000 each month. Because of the sheer size of mortgage repayments, it can be pretty easy to wind up struggling to pay them. A lot of people fall through the cracks each year and end up being forced into something called a mortgage default.
But what is mortgage default? What happens when you’re in default, and how can you avoid it? We answer those questions and more on this page.
What is a mortgage default?
Although there are several accepted definitions, a mortgage is generally considered to be in ‘default’ when the borrower falls behind on their home loan repayments by 90 days or more (three months). However, some credit agencies will record a default on a credit report if the repayment is more than 60 days overdue, provided the lender has sent written notice to the borrower seeking payment and a separate notice warning that the debt may be reported to a credit agency.
Default vs arrears: What’s the difference?
You might often see the words ‘arrears’ and ‘default’ used interchangeably, but there’s an important difference between them. Generally, arrears simply refers to a loan being behind in payments at any point. Most lenders offer a one or two week ‘grace period’ once you miss a payment, where any payment made during this period is still considered to be on time. After this, you are considered to be behind on your repayments and will be classed by the lender as being in arrears.
There’s any number of reasons why someone might fall into arrears. They might have lost their job or fallen ill, or interest rates might have massively increased to a point where they can’t keep up with their higher repayments.
After some time in arrears, the bank will send out a ‘notice of default’, which will give you 30 days to catch up with the repayments schedule. They are not allowed, by law, to offer a shorter notice period than this. A lender may send out the notice of default immediately after a repayment is missed, but most lenders won’t take this action until you reach that 90-day point.
Mortgage default and arrears statistics Australia
Quite a lot of Australian homeowners are in arrears. The illion Mortgage Nation Report for 2020 found that Australia has $20.4 billion worth of home loans in arrears, defined as at least 30 days behind in payments. That’s just over 1.10 per cent of Australia's total $1.84 trillion home loan market, according to Reserve Bank lending data. Only 0.9 per cent of those under 30 are over 30 days behind in their repayments, below the overall average, while Australian mortgagors aged over 70 are more likely to be in arrears and at risk of delinquency.
Amid the COVID-19 crisis, 11 per cent of residential loans were ‘deferred’, worth almost $200 billion in total. In Commonwealth Bank’s full-year results, 14 per cent of deferred home loans had at least one borrower that was receiving JobSeeker payments. According to Digital Finance Analytics (DFA), almost 100,000 Australians could end up defaulting on their loans should JobKeeper payments stop and JobSeeker return to its base rate.
In a normal year, DFA reports that around 83,000 Australians are at risk of default.
Mortgage stress and mortgage defaults
Another term you might have heard used interchangeably with arrears and defaults is mortgage stress; this is a different term altogether. Mortgage stress doesn’t have an ‘official’ definition, but it’s commonly accepted that if 30 per cent or more of your pre-tax income goes towards home loan repayments, then you are experiencing mortgage stress. Mortgage stress isn’t a good thing for someone to be experiencing, as it can reduce the money you have available for other living expenses, and, if it goes on for too long can ultimately lead to arrears and then default.
The latest mortgage stress statistics from DFA (which defines mortgage stress as when cash flow is negative, i.e. household expenses exceed household income) found a record 40.2 per cent of all households were experiencing mortgage stress as at July 2020, which is more than 1.5 million households. In December 2019, this number was much lower at 32.7 per cent, or 1.1 million households.
What happens when you default on your mortgage?
A variety of things can happen when you fall behind on your repayments or default on your mortgage, and none of them are good.
There are some fees that come with missing a mortgage payment, which can cost as much as $200 depending on the lender, and the interest on your loan can increase as you have to make up that lost payment over time. A mortgage default can also appear on your credit file too, which can negatively impact your credit rating and significantly hamper your borrowing capabilities in the future.
But the worst consequence of mortgage default is losing your home. If you fail to pay your overdue repayment by the strict deadline (often 30 days after the notice of default, no less by law), then the lender may repossess the property and sell it in order to recover the debt. If you’re struggling to get on top of your mortgage you can sell it yourself before the lender does, as this would likely be more financially beneficial for you.
Steps a lender will take when you default
Selling the house is usually the last step the lender will take, as it can be a huge pain to sell the house. In most cases they will contact you multiple times, send you a default notice and, in some cases, will refer you to their financial hardship team.
Usually, when you’re under default or are about to default on your mortgage, the lender will take the following steps:
- notify you of a missed or late repayment
- issue a notice of default (with 30 days to repay the overdue component)
- file a ‘statement of claim’ to begin legal proceedings for repossession of the property (if the overdue component isn’t paid within the 30 days).
Under consumer credit law, the lender does not have to give the borrower 30 days to repay if:
- the lender believes on reasonable grounds that it was induced by fraud by the debtor or mortgagor to enter into a credit contract or mortgage
- the lender has made reasonable attempts to locate the debtor or mortgagor without success
- the lender believes on reasonable grounds that urgent action is necessary to protect the mortgaged property.
But if none of these scenarios are applicable, then the lender is legally required to give you 30 days to pay the missed repayments before issuing a Statement of Claim. If you fail to file a defence against the court order within 28 days, the lender can obtain a judgement against you. After securing a judgement, the lender will typically give you a Notice to Vacate, telling you to move out. Sometimes a sheriff or bailiff will come to your home and evict you, changing the locks in the process.
If all of this seems too much, and you want to be aware of what your rights are when a lender tries to repossess your home, check out various websites like Consumer Action Law Centre or ASIC, and speak to a Financial Information Service Officer for free financial information.
What to do if you default on your mortgage
If you’re defaulting on your mortgage, or are just struggling to meet repayments, you generally have two choices:
- you can try to repay the loan by making changes
- you can downsize to a cheaper house and sell the one you’re in.
Both of these options can suit different situations.
Trying to repay your defaulted loan
If you’ve already been issued a default notice, then you need to contact your lender ASAP. Call them to discuss your current situation, as lenders are required to have financial hardship teams designed to help customers through tough times. It’s generally in a lender's interest to keep customers on their books instead of seizing the home from them, as they can continue to gain interest payments from a paying customer.
This is why by contacting your lender’s financial hardship team, they can help you by offering the following solutions:
- making repayment arrangements by working out a new budget based on your current repayments
- offering to change your loan’s repayments to interest-only for a time (which has cheaper short-term payments in exchange for higher payments after the interest-only period)
- extending your loan term and reducing ongoing repayments as a result (but making you pay more overall)
- delaying the loan repayments by offering a mortgage holiday or freeze (there are special mortgage holidays offered for those impacted by the coronavirus in 2020)
- potentially lowering your interest rate for a time (although this is less likely as a risky customer).
The Financial Rights Legal Centre sample letter generator can help you write a letter to send to your lender. The lender must inform you of its response to your hardship request within 21 days. If it decides to reject your request, it must give you a written reason why, and if you aren’t happy with their rejection:
- the lender must take it to its own internal dispute resolution team; then
- you can contact the Australian Financial Complaints Authority (AFCA) to make a complaint and get a free and independent dispute resolution.
You also don’t have to go via the hardship team if you don’t want to, although it is generally recommended. You can try and make cutbacks wherever necessary to save money for your home loan repayments, or you can even try refinancing your home loan, although this will probably be hard to do if you’ve defaulted.
Downsizing the house
If things don’t get any better, another course of action might be to sell your home before the lender repossesses it. This might not be an easy decision to make if you’re attached to your home, but it might be the right one, especially if you move to a cheaper house. A major factor in mortgage stress and later mortgage arrears and defaults is having a home loan that’s too expensive, so moving to a cheaper house could free up hundreds of extra dollars each month thanks to lower repayments.
Selling a house is a major financial decision, so strongly consider getting professional advice before you do. Legal advice and financial counselling are both available as free services in Australia for those in need. You’ll also need to let the lender know you intend to sell your existing property.
Alternatively, you could also consider the pros and cons of renting out a part of your house to earn a rental income, which could help with cash flow problems.
How to avoid defaulting in the first place
Defaulting is sometimes unavoidable in dire financial circumstances but sometimes there are ways you can avoid it if you act quickly enough. Try doing the following either before taking out a home loan or during.
- Build up an emergency savings buffer beforehand: You should always aim to have around three to six months’ worth of expenses set aside as an emergency savings buffer to call on when necessary, if possible. If you start to fall behind on mortgage repayments, you can draw on these savings to catch up.
- Don’t borrow outside your means: We touched on this earlier, but the more expensive the home the bigger your repayments will be. So, while it might be nice to get that nice inner-city, two-storey house with a big backyard, really consider if you could afford to meet the repayments on such a large purchase.
- Get a lower home loan interest rate: Besides buying an affordable home, arguably the most important thing you can do is to get a home loan with a low interest rate. Even a minor difference in rates can save you hundreds to thousands of dollars each year, so check out our home loan repayment calculator to see how much of a difference a lower home size and interest rate can make.
- Change your home loan if necessary: If you’re struggling to repay the loan in the short term, see if you can change to an interest-only loan for the time being, as these loans have lower repayments during the interest-only period. You could also speak to your lender to try and extend your loan term, or even refinance to a loan with a lower interest rate.
- Don’t be afraid to seek help: The worst thing you can do is to not do anything. Contact your lender to let them know you’re experiencing difficulty, as it’s in their interest to attempt to fix the situation. A paying customer is worth more to them than a non-paying customer.
Defaulting on your home is never a good thing, and in addition to leaving a stain on your credit file, it can result in your house being repossessed and you having to find somewhere else to live. This is a worst-case scenario for both you and the lender, which is why it’s imperative you contact your lender’s hardship team to find a solution.
Remember that it might not be too late to avoid going into mortgage default if you take the appropriate steps to remedy the situation.
Have you ever had to default on a mortgage? What happened in your situation?
William Jolly joined savings.com.au as a financial journalist in 2018, after spending two years at financial research firm Canstar. This article first appeared on savings.com.au
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