There is a lot of confusion out there regarding all things home loans and refinancing, but in particular surrounding interest rate buffers.
If you’re a current homeowner who is thinking about refinancing, or you’ve recently been denied a refinance application, we’re here to help. Loan Monster specialises in realising potential opportunities for homeowners that other brokers simply can’t. But first, let’s break down all things interest rate and mortgage buffers so you can make informed, educated decisions in your best financial interest.
Mortgage Buffers and Interest Rate Buffers
Banks and financial lenders use established buffers to reduce the possibility that a borrower cannot make their mortgage repayments and are required to default on their loan. Home loan buffers and interest rate buffers are two sides of this same coin.
Home Loan Buffer
The home loan buffer is a set amount of money that is put aside to pay for one’s home loan repayments in the event that you are unable to meet your monthly obligations.
Interest Rate Buffers
The interest rate buffer refers to the amount that an interest rate can rise without affecting a borrower’s ability to afford their mortgage repayments.
Mortgage Prison: Are you in it?
During times of economic periods and higher interest rates, homeowners can find themselves struggling to refinance their mortgages to a more affordable interest rate as they do not meet the required interest rate or home loan buffer. Being caught in this bind is referred to in the industry as mortgage prison.
It means that a borrower could be both struggling to meet current repayment obligations and also be unable to negotiate a change in terms as they are not considered capable of meeting the requirements for a refinancing. The rise in interest rates in recent years has made this issue even more of a problem for more and more homeowners.
But it is not just the increased interest rate that affects homeowners. It’s also the interest rate buffers as well. The interest rate buffer adds another bar over which you will need to hurdle in order to qualify for a loan.
Why are interest rate buffers important?
Interest rate buffers can be stressful and frustrating for homeowners, but they are important, nevertheless. The buffer adds an element of assuredness for a financial institution that there is enough flexibility in a borrower’s financial capacity to deal with changes in the interest rate.
Without the buffer, a potential borrower will be assessed on their ability to repay a loan only at the current interest rate. Without a buffer, any slight increase of an interest rate would put homeowners under financial distress.
For example, let’s say the interest rate on your loan is 5.24%. If the lending institution has a 3% interest rate buffer, you will be assessed on your ability to repay an interest rate of 8.24%.
In other words, if the interest rate increases anywhere up to 3% you will still be able to meet your repayment obligations.
Why is the Interest Rate Buffer lowering?
More and more lenders and banks are lowering the 3% serviceability buffer in order to attract new customers and borrowers. Some are reducing it to as low as 1%, such as the big banks, Commonwealth Bank and Westpac. Even NAB is offering lowered interest rate buffers on a case by case basis.
Why are they doing this? As interest rates rise, many homeowners are priced out of the market and are unable to refinance. The higher the interest rate, the less potential homeowners qualify for a mortgage according to the lending institution’s buffer-related policies.
By lowering the interest rate buffer, they are increasing the number of homeowners turning to them and successfully obtaining home loans, but at the cost of increased risk in the event of continually rising interest rates.
Does this benefit you?
In many ways a lower interest rate buffer does benefit you, if you are looking to refinance or if you were denied refinancing recently due to the high interest rates pushing the buffer level out of reach.
Lower buffers can be the key you need to break out of mortgage prison. There is of course an added risk, thanks to the lower buffer limit, that you could be negatively impacted by a further increase in rates. Strong savings habits and established mortgage buffers can help overcome that.
Should you consider refinancing?
Refinancing allows you to explore potential savings in your home loan by accessing better rates or better loans that suit your needs. Refinancing can save households a lot of money over the long run, so it’s an important consideration.
However between the ever-changing economic conditions and subsequent serviceability buffer requirements, it can be overwhelming to navigate the world of refinancing alone.
Call Loan Monster today
That’s why the team at Loan Monster is your best bet. Our brokers and specialists will help you escape from mortgage prison and explore the best refinancing options for your particular circumstances.
Whether you’re wondering what sort of mortgage buffer you need or how interest rate buffers could affect you moving forward, or you’re ready to start exploring refinancing options, give the Loan Monster team a call today!
