Refinancing a home loan in arrears

Mortgage arrears in Australia

Around 1% of mortgages in Australia are in 90+ day arrears, according to figures from the Reserve Bank of Australia (RBA).

This means around 1% of Australia’s outstanding home loans have borrowers that are overdue on their repayments by 90 days or more. Compared to other countries and other points in time, this rate of arrears is relatively low (arrears in the US hit 10% amid the global financial crisis), but it's still the highest it’s been in nearly a decade.

While the RBA often only looks at rates of 90+ day arrears, a loan is technically in arrears the moment a loan repayment is overdue. If you’re in this situation, refinancing could be a viable option to help you to get back on the right track, but the key word there is could.

Refinancing is the process of switching a mortgage to a different loan so as to get a lower interest rate, more flexible loan terms or to consolidate debt. When your home loan is in arrears, this can be a tricky business and might not always be possible.

Nonetheless, we’ll explore how to do it in this article and the pros and cons of doing so.

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How does a home loan fall into arrears?

If you have missed, late or overdue repayments on your home loan then it’s considered to be in arrears. This can often be a result of illness, job loss, divorce or other unexpected situations which have caused a borrower to not be able to meet their monthly mortgage repayments, or maybe you just bit off more than you could chew with the price of your home or the interest rate on your mortgage.

Even if falling into arrears is through no fault of your own, it’s an extremely serious situation which can eventually lead to your lender repossessing your home and selling it to recover their money. Following this, it could prevent you from obtaining a loan in the future, as arrears and potential repossession will leave a big black mark on your credit score.

There are ways to get yourself out of this hole, like refinancing, but it’s important to note that you should do everything you can to avoid getting to this stage. If you’re struggling, contact your lender before you default on a repayment and they may be able to provide you with alternative options.

In a speech delivered to a financial services gathering, RBA Deputy Governor Guy Debelle suggested that banks were becoming more patient with arrears.

"Liaison with banks suggests that more lenient forbearance and foreclosure policies have also contributed to the increase in longer-term arrears rates," Mr Debelle said.

This isn’t to say that it’s ok to be in arrears; it just shows how worthwhile it is to have an open line of communication with your lender regarding your financial woes.

How to refinance a home loan in arrears

Although refinancing a home loan in arrears is a valid option, it probably won’t be an easy one and it’s highly discretionary, judged on a case by case basis. Borrowers in arrears are considered ‘bad credit’ and as a result, some lenders won’t go near you.

This doesn’t mean you’re out of options though. Here are some general tips on how to approach refinancing a home loan in arrears:

Talk to your current lender

It’s often best to talk to your current lender to see what options they have, even prior to deciding to refinance. Despite what you might hear, lenders aren’t always faceless corporations, hellbent on profits. An open line of communication is usually the best way to foster a relationship and build up a level of trust. You’ll probably get far better results doing this than going in cold turkey, asking to refinance when your repayments are a month late, and having no prior communication.

Your current lender will also typically be more understanding than a new one and as such, are more likely to be open to you refinancing. A paying customer is more valuable to a lender than one who can’t meet their repayments, so it’s usually in a lender’s interest to try and work out an arrangement with you. Instead of having to refinance, some lenders, for example, might allow you to freeze your repayments temporarily to let you get your finances in order.

Most lenders are also required to have a specialised financial hardship team, specifically set up to explore options for those struggling with their mortgage. The Australian Banking Association has a complete list of phone numbers for a variety of different banks' hardship teams.

Get your credit in check

It’s vital to take stock of your credit situation so you can figure out where to go next - lenders will do the same when assessing you. With the introduction of Comprehensive Credit Reporting, good credit behaviour is now being rewarded.

Ensure you have no outstanding credit, minimise credit card use, pay all your bills on time and actually know what your credit score is. NAB has recently announced an initiative where any Australian can check their credit score for free, while other credit bureaus like Equifax or Experian offer a limited number of free credit checks per year.

See a mortgage broker

A 2018 ASIC survey of consumers who had taken out a loan in the previous 12 months reported that 56% went direct with a lender while 44% went through a mortgage broker. There’s generally an argument to be made for going it yourself, but this might not the case if your home loan is in arrears.

Mortgage brokers are experienced professionals and can help guide you through the often complex process of refinancing, which will only be made more complex due to the home loan being in arrears. A good mortgage broker could be well worth the investment to help you discover options suitable to your circumstance, and they're legally required to work in your best interests.

Consider a specialist lender

Major lenders will typically not approve you if they can see any arrears, no matter what situation you’re in, so you’ll generally have fewer options.

However, there are specialist lenders in Australia who have home loans specifically catered towards people with a bad credit history. These lenders will look over your credit history and could be more empathetic to situations out of your control that may have caused your home loan to fall into arrears. They also take into account more factors when deciding whether to lend to you and as a result, are usually likely to approve you for a loan.

Bear in mind that because you’ll be perceived as a riskier lender, any lender that’s willing to lend to you might only do so by charging higher interest rates and fees.

Borrow at an LVR of under 80%

If you’re already in financial hardship, the last thing you want is to be incurring more costs. Refinancing to a home loan with a loan to value ratio (LVR) over 80% often means you’ll be subject to lenders mortgage insurance (LMI). This can run up into the thousands, potentially rendering your refinancing efforts obsolete.

Of course, if money is tight enough to fall into arrears then borrowing under 80% LVR may not be possible, but it’s worth considering if you have the option.

Benefits of refinancing a home loan in arrears

Refinancing is by no means the definitive answer to solving a home loan in arrears but it could be a viable option when done correctly. Here are some of the benefits of refinancing a home loan in arrears:

• Consolidate debt - if you have several debts with a lender, they may allow you to roll this into one lump sum upon refinancing. This consolidation can help with budgeting efforts and make your repayments easier to keep track of, although this method is not without its flaws.
• Negotiate new terms with your lender - refinancing opens up an opportunity to reorganise the terms of your loan, albeit on the lender's terms. If you feel you may be able to repay your loan more easily via fortnightly repayments or wish to make extra repayments, refinancing can be a way to do so.

Risks of refinancing a home loan in arrears

Refinancing a home loan in arrears is not without its risks. Here’s some you might run into:

• Slip further into debt - some borrowers believe refinancing is the solution to all their problems, and refinance to a loan they still can’t afford. Falling into arrears a second time or soon after refinancing may rule out another refinance attempt and cause further debt or even repossession of the home.
• Higher interest rates - if you’re in arrears, it’s highly unlikely you’ll get a more competitive interest rate. Once you refinance and are subject to a higher interest rate, your repayments could be higher, again opening up the opportunity for a debt spiral.
• LMI and other fees - refinancing typically comes with fees such as application fees, valuation fees and settlement fees, just to name a few, while some specialist lenders are known to charge a risk fee. As well as this, borrowing at an LVR over 80% means you could be subject to the often costly LMI.
• Longer loan duration - if you’re looking to reduce your loan repayments immediately, lengthening your loan can be a quickfire way to do so. However, doing this will likely see you pay tens of thousands of dollars more in interest over the life of your loan. This method could provide short-term relief in exchange for more long-term costs.

What happens if your home loan remains in arrears?

The worst-case scenario of your home loan being in arrears is your house being repossessed, however, there are several steps prior to this happening.

1. The lender contacts you after you miss a repayment, either in the form of an email, phone call or letter.
2. The lender sends you a default notice, which gives you at least 30 days to catch up on your missed mortgage repayments. At this point, you can make your repayment, ask your lender to delay your repayments and apply for hardship or consider selling your property.
3. When your default notice period expires, your lender may take you to court so they can repossess your home and sell it to cover the cost of your loan. At this point, you should seek legal advice. There are a number of institutions across Australia that provide free legal advice and financial counselling - ASIC has compiled a list of them here.
4. If you have failed to take action, the lender will apply for a court order to gain possession of our home. Seek urgent legal advice if this happens.
5. Once the lender has obtained a court order they will send you a letter to tell you to move out. A sheriff, also known as a bailiff, will come and change the locks on your property if necessary. Seek legal advice even more urgently.
6. The lender evicts you from your home and sells it to recover the loan amount.

Case Study

Here’s an incredibly over-simplified example to showcase how refinancing a home loan in arrears works.

Barrie and Cassidy are a couple in their thirties with a property in Sydney. They borrowed $450,000 at a rate of 4.50% paid over 25 years at a monthly repayment of $2,502.

Ten years into the loan, Barrie falls ill and is off work for a year, causing their loan to fall into arrears. They still have $325,688 left to pay on their loan over 15 years.

Interest rates have dropped rapidly since they first took out the loan, so they go to their current lender and manage to negotiate a refinance, where they pay the remaining balance out over 25 years, extending the loan by ten years, and even manage to get a lower rate of 4.25%, which is still pretty high by current standards, but pretty good for someone in arrears refinancing.

As a result, their monthly repayment drops to a more manageable $1,765 per month, which allows them to keep their heads above water until Barrie can get back to work.

However, extending their loan by ten years means they’ll end up paying $80,364 more in interest in total than they would have if they stuck with their old loan, but they deemed this an acceptable price to pay in exchange for keeping their home.

Savings.com.au’s two cents

Although refinancing may seem like an easy way to get your home loan out of arrears, it can be fraught with danger. If you can avoid going into arrears, do so at all costs, as it often has a damning effect on your credit score and in some cases you won’t even be able to refinance.

Refinancing can also be littered with extra costs, and could actually be more expensive due to higher interest rates and fees a standard lender might charge you to compensate for your perceived risk,

If you think you might be in danger of missing home loan repayments, immediately contact your bank and open a line of communication.

If you’re thinking of refinancing your home loan in arrears, consider seeing a mortgage broker - their experience with lenders and industry could prove to be invaluable in your time of hardship. Consider getting free financial counselling or legal advice as well if things are really bad, and if it really comes down it, you might just have to bite the bullet and downsize to a cheaper home.

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