Home Loan Arrears vs Defaults: Differences and Implications

Paying off a mortgage can be a hard slog. Standard home loans come with terms of 25 to 30 years, and there are bound to be times during that period when finances don't flow quite as freely.

So, what happens if you fail to make a payment on time or fall behind on meeting your home loan repayments? Let's look at some terms you'll come across if this happens to you.

What does it mean to be in mortgage arrears?

A mortgage is said to be in arrears when the borrower has failed to make repayments according to the required schedule.

Home loans can be in arrears for any number of reasons: a transfer error, a borrower going on holidays or falling sick and forgetting to make a repayment, or a simple oversight.

In official terms, the Reserve Bank of Australia (RBA) defines home loan arrears as when a borrower misses a minimum scheduled repayment but are expected to return to fully servicing their loans.

Many lenders will grant some leeway to borrowers who fall into arrears, giving them the opportunity to catch up on their repayments without penalty or repercussion.

However, after a certain period of time - usually between five and 15 days, but sometimes up to a month - they will generally charge a late fee.

If you reach the end of the grace period without making the repayment, there's a good chance the late repayment will be recorded in your credit report.

A once-off infraction may not be too detrimental. But, if you're a repeat offender, not only will your lender take note, but it could work against you if you apply for credit in the future.

See also: Five ways to improve your credit score

What does it mean to default on your mortgage?

A default on your home loan is when you miss a repayment on the due date and have failed to take quick action to correct it.

Depending on your lender, you may be issued with what's called a 'notice of default' on the day the repayment becomes overdue, but most lenders will wait until your repayment is overdue by 90 days or more before considering your loan to be in default.

The default policy of your lender should be set out on your home loan contract.

A default on your home loan will be recorded on your credit report and have a much greater impact on your credit score than a late payment. Defaults remain on your credit report for a period of five years. (Note that some credit reporting agencies, such as Equifax, consider a default to occur after 60 days, regardless of your lender's timeframe.)

Once you've been issued with a default notice, your lender will give you 30 days to catch up on any repayments missed, plus any late fees owing. This is the time prescribed by legal and regulatory requirements to give borrowers sufficient time to come up with the funds.

When a default notice is issued, lenders are also legally required to provide you with information and assistance to access their financial hardship team.

What to do when your mortgage is in default

If you're able to pay what you owe, do so as soon as possible. It won't wipe the default from your credit record, but you will be back on track with your home loan.

If you're unable to pay - or feel you'll be back in the same position at some time in the future - you still have options. The most important action to take is to speak to your lender as soon as possible, ideally well before a default occurs, but it is never too late.

Every lender is legally required to assist borrowers through financial hardship. Lenders have dedicated hardship teams whose job it is to help you through tough times and keep your loan on their books. They might help you to:

• Defer your repayments

• Adjust your repayments to a lower amount for a fixed period and/or allow you to pay interest only for a time

• Delay what's called 'enforcement action' (the statutory process the lender can take to recoup the amount you owe)

Communication is key. If you don't respond to a default notice and your lender has made multiple attempts to contact you, you may get what is called a 'clearout' on your credit record. A clearout occurs when a lender has not been able to reach you and reasonably believes you're not going to repay your debt.

This can result in a lender taking legal steps to recoup the amount owing on your loan, even potentially repossessing your property, all without your input. It is also a major blow to a credit record.

How to avoid home loan arrears and defaults

Try to only borrow what you can afford to repay

This one is an important first step and should apply from day one of house hunting, well before you apply for a home loan.

Even with lenders' regulatory requirements, designed to protect borrowers from taking on more debt than they can afford, circumstances can change.

The post-pandemic run of interest rate rises and cost-of-living increases have seen many borrowers squeezed by their mortgage repayments.

Personal situations can also change and your ability to service your home loan can be affected by many factors including sickness, job loss, or relationship breakdown.

Starting out with an affordable home, a home loan you can easily meet the repayments for, and then building equity is generally a far better strategy than putting yourself under too much financial pressure from the outset.

With the average tenure of Australian homes at under 10 years, it pays to remember your first or current home is unlikely to be the one you'll live in forever.

Keep a savings buffer

Ideally, everyone should aim to have around three to six months' worth of expenses set aside in an easy-to-access emergency fund. It could be vital if you find yourself needing to meet late repayments and avoid mortgage default.

However, raiding the emergency fund won't be a long-term solution to servicing your home loan.

Pay interest only for a period

One way to avoid falling into arrears is to ask your lender if you can switch to paying interest only on your home loan until you get back on your financial feet.

This will effectively reduce the size of your repayments and hopefully help you from falling into arrears or defaulting on your loan during a difficult period.

This option is not without its repercussions, however. Our mortgage repayment calculator will give you some idea of how switching to interest only repayments for a period will impact your repayments over the remaining course of the loan.

Speak to your lender

It's in the best interests of your lender to keep you on its books and paying off your mortgage. If you're under mortgage stress, be upfront and ask what they can suggest.

Lenders deal with such circumstances every day. They may refer you to their financial hardship team or come up with a viable plan to help you through a rough patch.

The earlier you let them know you're struggling, the more options you will have.

Refinance

Investigate refinancing your loan with the same lender or a different lender to achieve a lower interest rate or different terms and conditions that will see you paying less for your home loan on a monthly basis.

Even a minor drop in an interest rate has the potential to save you a considerable sum. But, of course, this needs to be weighed up against the cost of switching loans.

To help you find the most competitive rate available, the table below features some of the lowest interest rates on the market for owner occupiers.

Important Information and Comparison Rate Warning

Downsize

Downsizing might sound like something older people do when the family home is too big for them. But downsizing doesn't just refer to selling up and buying something smaller.

You can downsize your mortgage too - and you don't necessarily have to move into a smaller space to do so.

You can achieve a less punishing mortgage by selling in the location you're in and purchasing in a more affordable one. You can move from one city or suburb to another, from a standalone home to an apartment, or from a major centre to a regional area.

If you make the decision to downsize your mortgage, the ball is in your court as to what option would best suit your circumstances. It's far better to take some decisive action yourself before your home loan pulls you under.

Get help

Beyond speaking to your lender, there are many services to help Australians struggling with debt.

The National Debt Helpline, on 1800 007 007, is a useful first stop, providing free advice and counselling on how to manage your debts.

Community legal services can also help if you've started down the path of being served with a default notice and need legal advice.

Community Legal Centres Australia provides a full list of centres operating in each state and territory.

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