One of the sad signs of the effect the Global Financial Crisis is having on Australia is the increasing number of people suffering "mortgage stress", and of mortgage foreclosures. In this Newsletter we shall have a look at mortgages, how they work and what you can do if you are facing difficulties.
When you sign a mortgage over property you give the lender (the mortgagee) security to cover repayment of the debt, but you also give yourself as security. This is known as a personal covenant, and is virtually universal.
The practical consequence is that if a lender sells up the property and does not recover enough to repay the debt, the borrower remains liable for the unpaid balance. If a borrower's financial position is bad enough for them to face a mortgagee sale, they are unlikely to have spare funds to pay out the balance, and bankruptcy may be the only realistic solution.
Many people shudder at the thought of a bankruptcy, but it is designed to give the insolvent a fresh start. Creditors are prevented from hounding you and after the bankruptcy period, usually three years you start again with a clean financial sheet.
Many of today's troubled borrowers fall into two categories. At the lower end of the market some borrowers have suffered a loss of income, and cannot keep up the required payments. If they borrowed a high percentage of the purchase price they may find that their property is now worth less than the debt - yes, property can go down in value!
At the higher end of the scale are investors who bought for negative gearing tax benefits, and with loss of income can neither service the interest bill or sell the property. Sometimes the position is made worse by the fact that the loan was with a fixed interest rate, and there are substantial "break fees" if the loan is paid out early following a sale.
What are break fees? If you borrow with a fixed interest rate you and the lender are betting on interest rates. You are hoping that rates will not go down, so you would be paying above the then going rate, and the lender is hoping rates do not go up, so it would not then be earning the current rate. If you want to get out of that bet, the lender wants to be reimbursed for the interest it would have earned if you had stuck with the deal. That reimbursement is the break fee, and the calculation method should be set out in your loan agreement.
If you are in trouble with your mortgage, what can you do? The first step is to talk to your lender sooner rather than later. Most lenders are appreciative of that and will be more inclined to be more cooperative than if they hear nothing while the debt gets bigger. The Department of Fair Trading will arrange for mediation to see if a resolution can be reached, and again sooner rather than later is the go. If nothing works, the lender will issue a Notice under the Real Property Act, and can then commence court proceedings to obtain possession of the property so that they can sell it.
Mortgagee sales are known as a source of cheap buys, so the lesson is that if you are in trouble, sell the property yourself as early as possible. Your debt will not keep growing, and you will probably be able to get more for it than the lender would.