High exit fees and a stricter lending environment combine to make an interesting refinancing dilemma for brokers and their clients...
Australians borrowers and their brokers are facing a refinancing dilemma.
On 3 February, The Reserve Bank of Australia slashed the cash rate by another 100 basis points, dropping the official lending rate it to 3.25%. This followed cumulative cuts of 3% in the last four months of 2008, spurred on by the worsening global crisis.
After facing 13 rate rises since December 2001, borrowers on standard variable rate loans rejoiced at their good fortune.
Unfortunately for the 43,632 borrowers who took out new fixed home loans in 2008 between March and September when rates were at their highest, it's a bitter pill.
Bad luck
Naturally, brokers can expect clients in this situation to be upset.
Gerard Tiffen, who has been a mortgage broker for 11 years, has been dealing with customers who fixed their loans at peak interest rates.
"That's the first time in my career I've ever seen someone go, 'oh my god, this is no good'," he confesses, but adds tat most are more distressed than angry.
"They understand that's life, that's the situation."
When this happens, Tiffen tries to go over the reasons why they chose a fixed rate in the first place. Then he discusses options with them and, in some cases, refinancing is the best one.
Refinancing
The top reasons why people refinance varies, says Fujitsu Consulting's Martin North.
"In the last 12 months the main reason was to address affordability concerns - some are always looking for the next great rate, we call them rate tarts - others are trying to answer their tight households budget."
But in 2009, North predicts many will look to maximise their opportunity to capitalise on the falling rates, and many will be looking to brokers to help them.
Joint research from JP Morgan and Fujitsu Consulting released in October 2008 found customers seeking to refinance for a better rate are more likely to use brokers, with 40% of loans originated by brokers churning on their advice.
It is potentially good news for brokers looking to boost their business, but familiar obstacles such as exit fees remain problematic and a few new obstacles such as stricter lending criteria will also limit activity.
Exit fees
"Conditional fees are a big problem. People go to refinance and find they have a massive penalty which they did not know about," North says.
Costly exit fees have long been a barrier to borrowers looking to refinance. They vary from lender to lender and can range from hundreds to thousands of dollars. Lenders claim the fees are compensation for the cost of breaking the contract. They are based on the loan amount, the time left on the fixed rate term and the difference between the fixed and current rates.
For example, a $250,000 mortgage fixed at 9% for a three-year term would have a break fee of about $18,000.
If rates dropped 1% in the next 2.5 years then borrowers would break even. Should rates drop lower than that, they can potentially save money.
The government has been evaluating exit fees as a barrier to competition for several months. The House of Representatives Standing Committee on Economics released a report Competition in the banking and non-banking sectors in November 2008, in which it stated that there is community concern about the current level of entry and exit fees on some mortgage products.
As a result, it recommended that "as part of the adoption of responsibility for the regulation of credit and the introduction of a national consumer policy framework, the government consider mechanisms for making entry and exit fees more transparent and for addressing unfair entry and exit fees."
The House of Representatives also recommended that the Treasury create "standardised key facts document for mortgage products, based on the UK model, to help consumers to compare financial products. The standardised key facts document must be provided to the committee within twelve months".
In the meantime, North argues brokers have a responsibility to educate borrowers on fees.
"Make sure consumers understand the full costs of refinancing, and are provided with good choices - they also need guidance on fixed versus variable - as rates drop consumers might be encouraged to lock in a good long terms rate - but beware the fees."
Lending criteria
The other major obstacle for people looking to refinance is stricter lending criteria, particularly for borrowers looking for low-doc or no-doc mortgage products.
In the last year maximum LVR ratios for low-doc loans have tightened from 80% to 60%.
Mortgage insurers are partly responsible for the changing lending landscape.
Genworth now requires low-doc borrowers to provide business activity statements and has cut its coverage of 100% loans. QBE LMI has also withdrawn its coverage on loans with LVRs above 95% and increased premiums on high LVR loans by 15% in some cases.
Major lenders have instituted changes of their own. ANZ only provides low-doc loans for mortgages with LVRs of 60% or less, while CBA now requires self-employed borrowers to provide a year's worth of business activity statements. St. George bank requires its low-doc borrowers to have GST registration for a minimum of 12 months and has excluded borrower types such as company and trust uses.
In the past, borrowers and brokers have turned to non-bank lenders to address their needs.
But the lack of available funding and new rules introduced by the Australian Office of Financial Management curtail non-banks' ability to service low-doc/no-doc borrowers.
Government investment in the non-bank sector comes with restrictions. Recipients of the AOFM's $8bn scheme must limit low-doc loans to 10% of their mortgage portfolio, loan sizes must be under $750 k and the weighted average LVR must not exceed 70%.
An inability to refinance could mean greater defaults.
"One of our concerns going forward is with the banks and non-banks becoming more conservative with their lending practices is it will leave more people stranded - if they're in a non-conforming product, or a low-doc product, or a high-LVR product especially in a falling price property market, there will be more of these people that are left with less options - either to pay or default," says Ben McCarthy, managing director, Fitch Ratings.
Fitch Ratings latest postcode report, which shows delinquency by post code, revealed a higher number of defaults in areas where property prices "are effectively going backwards".
In a rising property market it's harder to see mortgage stress, McCarthy says, because people either sell their property for a profit or they refinance.
Until the lending landscape changes, borrowers and brokers will be hard-pressed to see their way out of this refinancing dilemma.
