Occasionally you see a situation where a group of individuals become “fish in a barrel” – able to be reeled in at will no matter how fast they swim around and around.
Surprisingly, at the moment there are two such groups who will struggle to escape from their barrels, despite one of the groups being exceptionally wealthy.
The first group – and the one we should feel the most sympathy for – are the growing group of pandemic-era home buying mortgage prisoners who are now effectively unable to change lenders.
And the second group are those people who have truly large self-managed superannuation funds, which now face paying a hefty tax impost due to the doubling of the superannuation earnings tax, a situation that will be very difficult but not impossible to remedy.
How borrowers became trapped
First to the situation of the mortgage prisoners, who can’t really escape their current lender because they no longer meet lending standards due to the large rise in interest rates since they took out their loan during the last three years.
That is because when they took out their loan, their “serviceability buffer” which is used by a lender to assess the customer’s ability to meet repayments, was 2.5% above the current interest rate.
Since then, however, interest rates on housing loans have risen by 3.5% or more, smashing right through their old serviceability buffer.
Even worse, the serviceability buffer on a new loan has since been increased to 3%, making it highly unlikely that they can change lenders quickly and easily.
On struggle street with no escape
Of course, that depends on personal circumstances such as the size of the loan relative to income and whether that income has increased since the original loan was taken out but nevertheless, the ability to switch lenders will be constrained by the ability to service a “theoretical” loan rate that is a full 6.5% higher than their original loan rate.
Add in the fact that these borrowers are likely to also be having great difficulty – perhaps even experiencing negative cash flow – paying off their existing loan and the circumstances and their consequences may be severe.
Being able to switch lenders is actually a vital tool in the current lending market.
Canstar finds massive loan differences
Research from financial comparisons site Canstar showed that almost one-quarter of owner-occupiers making principal and interest repayments are on interest rates above 6.5%.
That compares to some available loans as low as 4.7%, which could be an absolute lifeline for the mortgage prisoners if they could grab it, considering that the difference on a $500,000 mortgage would be $570 a month.
Canstar found that some borrowers are paying more than 8% for high-rate loans taken out many years ago, representing $1,150 in additional repayments a month for a $500,000 loan.
If the borrower can’t refinance, perhaps one of their only remaining options is to negotiate with their current lender on hardship grounds for either a switch to an interest only loan for a period or perhaps lengthening the term of the loan.
Neither option is particularly palatable but they are arguably better than being forced into a sale.
Signs of stress emerging
While home borrowers have been remarkably resilient in meeting higher repayments at this stage, there are now unmistakable signs of stress with ratings agency Fitch discovering an increase in mortgage holders falling more than 30 days behind in repayments – a sign of increasing mortgage stress.
Reserve Bank of Australia modelling has shown that at current interest rates, about 15% of mortgaged households with variable rates would experience “negative cash flow”, in which their spending is greater than their income.
That is unsustainable in the longer term, with either severe spending cutbacks, extra income or loans from family members some of the only options to avoid a forced sale.
Break out the tiny violins
While they may only deserve the playing of a tiny violin, many of the owners of some of Australia’s top 100 super funds also face a conundrum due to the 30% tax rate on earnings, which will eventually apply to individuals with more than $3 million in super.
The latest numbers show that the biggest 100 SMSFs now hold more than $12 billion, making this another admittedly plush and exclusive barrel to be trapped in.
The top five self-managed super funds alone had average assets of $379 million while the smallest fund among the top 100 held a still substantial $65 million.
$250m of tax breaks
According to super expert Brendan Coates from the Grattan Institute, these top funds are now enjoying tax breaks worth about $250 million a year, so any dent in that is hardly a cause for rioting in the streets.
His calculations are that using an average of two people in each top 100 fund, the potential extra tax take under the controversial new rules that come into force in 2025/2026, was about $100 million a year.
The highest number of members in a self-managed fund is six, but even if that applied to every fund in the top 100 the members would still all be above the $3 million threshold.
Most of the money in these huge funds was most likely tipped in before 2007, when the government capped contributions to funds.
Mr Coates said it is highly unlikely that much of the money in these top 100 funds would be used to finance retirement and instead they were effectively a “taxpayer funded inheritance scheme”.
Reducing the amounts within these massive funds is difficult given the preservation rules around super, although there are strategies around moving funds between accumulation and pension modes that might help to reduce the tax bills for the top 100 funds, along with the use of franked dividends and large withdrawals for members in pension mode and older than 60.
Moving funds between members is difficult
Another complication facing the top 100 is that you can’t simply swap money between family members within a super fund – so a couple might have $6 million in super between them but can’t “even that out” so that they have $3 million each to avoid the tax.
Since the changes have been announced there has been a distinct shift in professional advice for wealthy families, with many advisers now recommending other strategies involving the use of family trusts and personal investment companies to increase flexibility and reduce tax burdens.
Advisers have also been changing super strategies to reduce the impact of the changes on wealthy people, mainly around “evening up” funds between couples using contributions to reduce the overall tax burden and perhaps trying to move funds out of super before the new tax comes in.
It may be hard to summon too much sympathy for those within the top 100 super funds in Australia but what was once a sort of status symbol has now become a very elaborate barrel in which a lot of very large fish are now circumnavigating.
