Could climate change increase your risk of "mortgage prison"?

Economic factors such as inflation, the cost of living, and rising interest rates could see Australians at higher risk of “mortgage prison”, where they’re unable to refinance their home loans. Now the Reserve Bank of Australia (RBA) is highlighting the risk that climate change poses to your personal finances, as well as the economy as a whole.

In a speech to the Credit Law Conference, RBA head of domestic markets, Jonathan Kearns, laid out the risks that climate changes poses to Australia’s financial system, including:

• Acute physical risk e.g. losses due to severe weather events such as flooding, storms and bushfires
• Chronic physical risk e.g. higher temperatures and sea levels and lower rainfall affecting the production from farmland and the value of some housing
• Transition risk e.g. changes to policies and preferences affecting the economy
• Liability risk e.g. businesses failing to sufficiently respond to climate change

Dr Kearns said that climate change could significantly affect the value of assets used as security for loans, as well as the incomes used to make repayments on loans. He also highlighted the climate risk to banks and mortgage holders over time, as new housing mortgages are typically for terms of 25 years, and over this time “the effects of climate change are likely to be significant but are also very uncertain.”

“In practice, most mortgages have a shorter effective life because the borrower refinances, moves or pays the loan off early. But if climate change makes a home's location less desirable and significantly reduces its value, the borrower may have less opportunity to refinance or upgrade their property. The lender may then find that the loan on that property has a much longer realised maturity, and the collateral backing the loan has a lower value.”

This is in line with recent RateCity analysis that found Australian median house prices could drop by over $150,000 by the end of next year, which could put those who only bought their property recently (such as Australians who took advantage of the federal government’s low deposit scheme) at risk of ending up in negative equity. 

Additionally, banks typically require mortgage holders to insure their property, which may also be being affected by climate change. For example, housing in some areas of Australia is forecast to become “uninsurable” in the future due to the higher risk of extreme weather events. Plus, over a million Australians were found to be spending more than four weeks’ income on home insurance. 

All of these factors, combined with rising home loan interest rates, could see some Australians at higher risk of finding themselves in “mortgage prison”, where they’re struggling to afford the repayments on a mortgage that they can’t easily refinance.

What can you do?

Dr Kearns said that “it is critical for central banks and financial regulators to carefully analyse and respond to climate-related risks.”

“These are complex issues and our understanding of how best to respond will evolve over time. But it is critical that financial market participants and regulators act now to best manage the financial risks and facilitate the associated opportunities.”

Halting and reversing the effects of climate change is a monumental task for humanity as a whole, but there are a few steps that everyday Australians may be able to take to help safeguard their personal finances, such as:

• Checking your home insurance
• Estimating your current equity – get a free property report to estimate your current home value
• Comparing home loans for refinancing
• Considering making extra repayments and/or using offset accounts to build mortgage buffers
• Checking your credit score
• Looking into sustainable home upgrades

Compare home loans in Australia