The Reserve Bank have released some statistics on how Australian families are struggling with household debt, including mortgage repayments.

ABC News has reported that although most people are managing to keep up with their repayments, about one-third of mortgage holders don’t have a significant buffer (savings, mortgage offset, etc) to protect themselves from changes in the economy such as interest rate fluctuations or employment shifts.

The report stated “Rising indebtedness can make households more vulnerable to potential income declines and higher interest rates,” which is bad news for the economy because “a highly indebted household sector is likely to be more sensitive to declines in income and wealth and may respond by reducing consumption sharply.” Lower household spending can mean an overall economic downturn as people naturally tighten their belts.

So what has led to all this concern about mortgages? The Reserve Bank has indicated that the biggest domestic threat to economic stability in Australia comes from household debt and rising property prices. The property bubble will inevitably burst, leaving not only property investors struggling but puts families’ financial situations as great risk. Working to develop a mortgage buffer may be one good way for homeowners to protect themselves from the potential collateral damage.

One of the easiest ways to create a mortgage buffer is to divide your monthly mortgage payment by 4 and pay that amount weekly, or 2 and pay that amount fortnightly. It reduces the length of the loan and the amount of interest paid.  It will create a buffer because there are 4 more weeks than months every year.

A trap for many borrowers is relying on mortgage insurance. Lenders will insist on it being taken if the deposit on a home or property is under 20% of the value of the loan. What many people don’t realise is this only protects the bank from losing money if the home is repossessed. The borrower may still owe the bank for the difference between what the home has been resold for and how much of the loan is outstanding.

The fallout from the bubble bursting is very different for Australia than the US. In the US, when a homeowner defaults on their mortgage, they hand the keys back to the bank and the debt is then the banks responsibility. If they have lent too much money, the bank wears the loss when the property is resold. In Australia, there is no mechanism to protect the homeowner, the protection is for the bank. If you are left with a house you paid $800,000 for and it’s value is now $600,000 you the borrower are still responsible for the debt on the higher amount. Additionally, if you go to refinance, the next lender will only lend on the lower value – $600,000. Essentially locking you in until the loan diminishes below the revised value of the house. Which means you cannot extend the loan for home improvements either, because what is owing is already greater than the value of the home.