Mortgage Default 101: What Happens & What To Do When You Default

A mortgage default refers to the failure of a mortgage owner to meet their scheduled repayments, typically after a grace period.

Understanding how mortgage default works is critical for homeowners because even a short lapse in repayment can trigger a chain reaction of fees, credit score damage, and potential property repossession, while consumer rights and strict lending regulations in Australia aim to balance the interests of both borrowers and lenders. 

This guide explores the default process in detail and offers you practical advice on managing financial challenges to understand your rights and navigate your options if you ever fall behind on your mortgage repayments.

Understanding Mortgage Default

A mortgage default generally occurs when a mortgage owner misses their scheduled repayments and fails to catch up within a set timeframe or grace period. 

The grace period varies depending on your lender, but it’s usually 90 days for most lenders in Australia.

So if you miss your mortgage repayment on the due date and still fail to pay it back within the 90 days of grace period, that’s considered a mortgage default.

Causes of Mortgage Default in Australia

Mortgage defaults rarely stem from a single factor. Instead, they usually result from a combination of financial pressures and market conditions. Key triggers include:

• Financial hardship: Sudden life changes, such as job loss, reduced income, or unexpected expenses, can quickly undermine your ability to meet monthly repayments. 

• Rising financial demands: Climbing interest rates, coupled with higher living costs, can stretch household budgets to the limit.

• Mortgage stress: The financial hurdles along with paying more than 30% of your total income towards mortgage puts you in mortgage stress. It’s a very risky position to be in, as an unexpected expense or decrease in income can easily force you into defaulting on your mortgage.

• Negative equity: Falling property values can leave you with a mortgage balance that exceeds the value of your home. Negative equity reduces your options to refinance or sell without incurring losses, making default a more likely outcome if additional financial stress occurs.

• Poor financial planning: Over-borrowing, poor budgeting, and insufficient savings buffers can leave you exposed to even minor economic shocks, which can quickly escalate into a default scenario.

What Happens When You Default?

Defaulting triggers a set of events that could put you in immense financial risk if not managed right. Before learning to mitigate the issue, you need to know exactly what entails the point of defaulting on your mortgage.

1. Immediate Financial Consequences

Missing your repayment can trigger late fees and accumulated interest charges that you may be required to pay down together at once. These extra costs compound the amount you owe, making it even more challenging to catch up on your payments.

A default is also recorded on your credit report. An important note here is that even if your lender has a 90-day tolerance period (varies by lender), some credit agencies may record the default in a lesser timeframe (generally 60 days across Australia).

Again, the timeframe required for the default to be reflected in credit reports depends on credit reporting bodies. 

Once recorded, your credit rating will experience a significant drop, marking you as a higher-risk borrower, which in turn reduces your ability to get future loans or favourable interest rates.

2. Default Notice & Lender Actions

During the grace period, your lender will try to contact and constantly follow up with you regarding the overdue payment via letters, emails, or phone calls.

However, after this tolerance period, your lender will send you a default notice, which specifies a cue period (often a window of 30 days, but may vary according to lender) to bring your account up to date by paying all the overdue amount plus any fees and charges.

It might also contain the option for a financial hardship arrangement with the lender, to help borrowers who are in financial distress and cannot meet the cue period.

You can initiate this arrangement to discover any options that may be available to help you navigate the mortgage payments during your inability to repay.

3. Legal and Long-Term Outcomes

If you fail to fix the default within the provided timeline in the default notice and are unable to come to any suitable financial hardship arrangement with them, the lender may commence repossession proceedings.

This entails legal actions to take possession of your property, which may eventually lead to its sale in order to recover the outstanding debt.

How to Avoid Mortgage Default

To avoid defaulting on your mortgage, you need to adopt proactive financial planning and smart money management before you even take the mortgage.

Here are some practical steps to keep your mortgage repayment manageable, safeguard your home, and maintain financial health:

Create and Maintain an Emergency Savings Fund

Building a dedicated savings buffer can help you cover unexpected expenses or a temporary loss of income without falling behind on your repayments. Aim to set aside at least three to six months’ worth of living expenses.

Build a Realistic Budget

Develop a budget that accurately reflects your income, expenses, and financial goals. Regularly track your cash flow to identify any potential shortfalls early on and make necessary adjustments to avoid overspending.

Avoid Over-Borrowing

Before taking on additional debt, evaluate how much you can realistically afford. Use an online mortgage repayment calculator or consult a financial advisor to understand your borrowing limits and avoid taking on loans that exceed your repayment capacity.

Utilise Offset Accounts

A mortgage offset account is an everyday transaction account that links to your mortgage. The balance in this account offsets your loan balance, reducing the interest charged on your mortgage.

You can use it to keep your mortgage expense down.

Regularly Review and Adjust Your Repayments

Your income, expenses, and interest rates are prone to change with time, affecting your ability repay your mortgage every time these components change. 

Periodically reassess your repayment plan to ensure it remains in line with your current financial situation.

What To Do When You Default: Practical Steps

Let’s say you unfortunately did default. It’s a puzzling situation to be in since you’ll be overwhelmed by the emotions and the pressure from your lender.

First and foremost, don’t let the emotions drive you. Keep calm and start taking the mitigation steps one by one.

Immediate Actions

Reach out to your lender as soon as possible. Explain your situation and inquire about any available hardship arrangement options before the issue escalates.

Then, gather your financial documents (recent pay slips, bank statements, expense records, etc.) to get a clear picture of your current financial state. Use this to review your budget and see how you can realistically plan ahead.

Hardship Variations

Request your lender for a temporary pause, reduction in your repayments, or forbearance.

Under the National Consumer Credit Protection Act 2009 (National Credit Act), lenders are required to consider hardship applications, potentially offering reasonable solutions to help you out while you regain financial stability.

Refinancing

Explore options to modify your mortgage. You can do this by refinancing the mortgage to extend the loan term, switching to an interest-only repayment plan, or adjusting other terms to reduce your monthly burden.

Your current lender most likely won’t let you refinance with them, so you may have to look for a new lender to refinance with. To find the right options for you, consider using a refinance broker to explore multiple options at once.

Redraw

If you have the redraw facility available with your mortgage, and you’ve paid extra funds in the past, you can redraw these extra funds now.

Use these extra funds to pay off your overdue amount.

Voluntary Sale or Downsizing

Letting go of your property is one of the hardest decisions to make. But it all else fails, this is your only way out.

Selling the property yourself before the lender initiates repossession might be a viable option. This can help you avoid a forced sale, which may result in a lower selling price and additional deficiency debts.

You can either use the net proceeds from this sale to pay off the entire mortgage, or just pay back the overdue amount and downsize into a smaller property.

Seek Professional Guidance

The Australian Financial Complaints Authority (AFCA) is an Australian government entity that provides an independent dispute resolution service. 

If you feel your lender has not followed proper procedures or are dissatisfied with a hardship outcome, you can escalate a complaint to AFCA.

In addition to this, a mortgage broker can help you explore refinancing or loan modification options, while a legal expert can offer advice on your rights and assist in navigating any disputes or hardship applications.

If you need an unbiased mortgage broker to help you out, get in touch with us. Access 2,000+ loan options from 30+ top lenders across Australia to find the most suitable mortgage solution you need.

We help you from start to finish for FREE, without any broker fees or commission!

An Example Scenario of Navigating Mortgage Default

Consider the case of Mark, an average Australian homeowner. Mark purchased his home for $500,000 with a $400,000 mortgage, at a 6% interest rate for 20 years.

With this setup, Mark is required to pay $2,870 as monthly repayment. When he unexpectedly lost his job, his income dropped sharply, and he struggled to meet his repayments.

1. Recognition

Mark missed his July repayment. As soon as it became overdue, the lender started contacting him about the issue.

Even though he promised to pay it back in a few days, he failed to do so and became overdue by 60 days.

The bank constantly followed up with him during this time, which was their tolerance period.

2. Initial Impact

Within 60 days, the missed payment was reported to credit agencies, causing Mark’s credit score to drop. Late fees and compounded interests (roughly an extra $400) added to his arrears.

3. Immediate Action

Mark reached out to his lender, explained his situation, and inquired about available hardship options before the issue escalated.

The lender offered a temporary hardship plan, including a short-term interest-only period for three months. This arrangement allowed Mark to reduce his monthly outlay while he reassessed his financial situation.

4. Reviewing Finances

With the arrangement in place, Mark now has the freedom to review and adjust his finances. He gathered his recent pay slips, bank statements, and expense records to take a close look at his finances.

He cut non-essential expenses and adjusted his budget to prioritise essential payments.

Mark then dipped into his emergency savings of $5,000, using part of this to cover the overdue payments. Plus, he also accessed around $1,500 through the redraw facility to pay off the rest of the overdue amount.

5. Refinancing

Since Mark lost his job and still hasn’t found another one, he understands the challenge of maintaining a 20-year term with his currently limited income.

So he consulted a refinance broker to explore refinancing options that would help him lower his monthly commitments, either by extending the loan term or reducing the interest rate.

The broker proposed a refinancing solution that included a 5% interest rate with a 25-year tenure, significantly reducing the burden on Mark.

In case this refinance wasn’t possible, Mark would’ve had to downsize by selling his current property and buying a more affordable one.

The information in this article is general in nature and does not take into account your personal objectives, financial situation, or needs. It is not intended to be financial or legal advice. Please consult a qualified professional before making any decisions.

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