High interest rates and faltering property values in Australia and recession in the US are creating "the perfect storm" for debt-laden consumers, according to the author of a research paper on mortage stress. Fujitsu Consulting and JP Morgan's latest data predict that almost 1 million households will experience mortgage stress by September, with 40 per cent of those under severe stress.

For those in severe stress, the prognosis is poor - half are expected to lose their homes.

The bleak findings follow several recent reports predicting Australia's property bubble is about to burst and that property prices will fall by as much as 25 per cent.

"We've got all these things coming together: global trends of recession in the US and potentially in Europe; the credit crunch continuing to lift rates for consumers and also to banks and business; we have [housing] affordability at its lowest level and debt as high as it's ever been. I think all of these things together are creating the perfect storm," says Martin North, the managing consulting director of Fujitsu Consulting.

With home price falls recorded during February in about a third of Sydney's and Melbourne's suburbs, some Australian home owners face the prospect of negative equity - where they owe more on their mortgage than their house is worth.

The bad news comes as no surprise to David Tennant, the head of Care, a financial counselling service in Canberra that is at the front line of the debt crisis. His service is receiving calls for assistance with mortgage foreclosures several times a week. A decade ago it would take one or two a year.

"For most of the past 10 years we've been saying to just about anyone who'll listen that the accumulation of debt is unsustainable and will end badly," he says. "It's only in the past six to 12 months that there's been a broader recognition there was substance to those warnings. The crisis we were predicting has already arrived."

The NSW Government this month promised financial counselling services worth $1 million to help them along.

How did it get this bad? And more importantly, what can you do about protecting your home?

Mortgage stress

Fujitsu Consulting and JP Morgan's latest mortgage stress data predict that by September, nearly 300,000 new households nationally will join the 700,000 (or 13 per cent) of households already experiencing mortgage stress, which it defines more narrowly than the blunt 30-per-cent-of-income rule of thumb.

"Say seven million people have mortgages," North says. "So one-seventh of the population are now in stress. That's as high as it's ever been. If you compare the ratio of mild stress to severe stress, there's slightly higher severe stress in the latest numbers."

Fujitsu's Anatomy of Australian Mortgage Stress report, to be released tomorrow, shows that NSW, Victoria and some population segments in Western Australia are the worst hit, with defaults and forced sales highest in NSW.

Even more disturbing, on present trends a household in severe stress has only a 50 per cent chance of saving the house, North says.

Fujitsu predicts that every 25 basis points rise in the mortgage interest rate from now on will push 150,000 more households into mild stress, and half again into severe stress.

The report also shows that the time people spend on "the stress escalator" is shrinking.

At the moment it takes on average three years from the first experience of mild stress to losing the home through foreclosure. That period is shortening due to rate rises.

The Australian Banking Association disputes Fujitsu's analysis on the basis that the number of loans in arrears recently dropped.

"The proportion of housing loans with repayments that are 90 days late fell to 0.32 per cent in the December quarter last year, down from 0.36 per cent recorded in the September quarter," says its head, David Bell.

But North points out there is a time lag. He argues that mortgage stress is experienced for some time before households default - the bankers' definition of mortgage stress overlooks home owners who rely on credit cards to cover shortfalls after paying the mortgage.

"One of the biggest things we've noticed over the past two months is people who've maxed out on their credit cards and now don't have the ability to continue to [cover] their other expenses."

Tony Devlin, the head of the Salvation Army's financial counselling arm, Money Care, says there is often an even worse outcome waiting for people who lose their home.

"We often find if you get in trouble with your mortgage, there's usually credit card debts involved too. Then you [have] a very poor credit history," he says.

"If the house does get repossessed or you're forced to sell, you find it very hard to get a rental property because you have such a poor credit history. You go from having a house to being hardly able to find rental accommodation.

"It's really scary stuff."

House prices to tumble?

Earlier this month, the IMF issued an uncharacteristically bearish warning about Australian property prices. After a decade-long boom in the sector, it says, Australian housing prices are now 25 per cent higher than could be explained by fundamental trends.

Morgan Stanley also predicts a 50 per cent drop in house prices in some areas. Others predict the tight rental market and high immigration levels will keep housing prices relatively strong: BIS Shrapnel predicts house prices will actually grow by 40 per cent over the next five years. Yet property research group Residex estimates small falls have already hit one-third of Sydney's suburbs, 35 per cent of Melbourne's and 55 per cent in Perth.

Who should you listen to?

Analyst Greg Canavan of Fat Prophets says a 30 per cent fall in house prices across the board is not realistic, yet "significant falls" are likely over the next few years. New figures prepared by Australian Property Monitors for the Weekend AFR suggest that more home owners at the top of the NSW market are coming under pressure, too. During February there were 14 per cent more homes worth more than $1 million on sale than at the same time last year.

Fat Prophets currently advises its clients to think very hard before investing in property, despite the wobbly stockmarket. "Easy credit led to the property boom in the first place, so why would tighter credit conditions lead to a property market revival?" Canavan asks.

Demand for housing varies greatly with area, while the impacts of mortgage stress hit certain suburbs harder than others. That cushions some suburbs but condemns others: falling house prices are compounded if several in the same area are forced to sell.

A debt crisis?

Economist Steve Keen, the author of Debunking Economics, is in no doubt that we're in a debt crisis and says a recession in the next two years is inevitable. (North puts the recession risk at 40 per cent.)

"Our GDP is $1.1 trillion, our private debt [household plus business] is $1.8 trillion," Dr Keen says.

"That means it's 170 per cent of GDP. Even in the Great Depression the ratio was only 78 per cent."

That figure does not include financial sector debt. Keen identifies three major contributing factors: "Regulators who believed they can rely on the market to set prudent levels of debt. Financiers who are quite legitimately following an incentive in the system that encourages them to lend as much money as people are willing to absorb. And individuals who are convinced that buying an asset and watching its price rise is an investment."

Keen says the mortgage industry has played a large role in driving the debt crisis. As recently as 1990, he says, household debt was about 20 per cent of GDP compared with business debt, which was 60 per cent.

Mortgage lending has taken off and is now equal to about 100 per cent of GDP.

"It's all due to the mortgage industry's 'we'll save you' garbage," Keen says. "They gave everyone money to go and gamble against each other to drive prices up. What lies behind the debt bubble [in the US] are people speculating on both houses and shares. In Australia we've mainly speculated on housing but at the end of the whole thing we've also gambled on the stockmarket with margin lending."

Keen also predicts the number of Australian households already in negative equity will grow.

Responsibility lies all along the chain, from lax lending standards, unscrupulous mortgage brokers (who are still not regulated nationally), over-enthusiastic valuers and consumer overreach.

"There was a time when people were really desperate to get into the property market because of fear they'd miss out totally," Devlin says.

"People were strongly encouraged to get a mortgage by advertising, real estate agents, brokers, banks.

"It is true that the non-bank financial institutions were significantly involved, I know that's the ABA's line; but the banks are certainly involved as well. We've had clients who have had houses repossessed by the big banks."

Care's Tennant says: "It really goes back to the very basics of how lenders contemplate the issue of affordability and the questions they ask around that. They have gone to extraordinary lengths over the past decade to find ever more inventive ways of not checking real capacity [to pay] before the end, instead looking to the asset base.

"This is not just a problem that's exclusive to the non-mainstream lenders. Equally, mainstream lenders for years have been disconnecting their lending practices from ongoing relationships. The credit card market is the prime example."

What it means

Tennant insists most of the people he deals with haven't done anything significantly wrong.

"They haven't been greedy or stupid. The underlying issues are that costs have risen at an unsustainable rate, incomes have not kept pace.

"Asset values continuing to rise gave them something of a buffer.

"But now there's pressure on asset values and the cost of debt continues to increase faster than incomes, so the inevitable consequence is people can't keep up."

For the highly leveraged consumer, the writing is on the wall. "The best thing anybody who is leveraged can do is de-leverage," Keen says.

"If you get out of it before anybody else, then that's to your advantage.

"The trouble is, that's an individual action that actually accelerates the problem on the social level - if we all stop spending, it's hello recession."

Nicholas Gruen, an economist and a director of Melbourne mortgage broker Peach Home Loans, has similar advice.

"I don't believe people should ever highly leverage - unless they know something that the market doesn't," he says.

But it's not so clear cut for home owners. North says the tight rental market complicates the issue: "People who are considering selling up are discovering that the costs of [renting a property] are as high as their mortgage repayments.

"Even if they do sell up, they've still got a financial problem. So selling up isn't necessarily the answer."

The Australian Securities and Investment Commission recommends borrowers in stress consider all options before refinancing, including negotiating with their existing lender for temporary relief; examining all alternative loan options available; downsizing to a smaller property; or selling the home and investing the lump sum in the hope of buying another home in the future.

"Sometimes it's hard for people to admit that it's time to jump out," says Carolyn Bond, the chief executive of Melbourne's Consumer Action Law Centre.

"But if you jump out earlier, you can often retain a bit more of the money that you put into the house than if you hang in there and let all your equity be eaten up by broker fees and refinancing fees," she says.

'Refinancing is not the silver bullet'

Households that get into severe mortgage stress typically attempt one or two refinances before the end. The Fujitsu research shows that refinancing in fact increases your likelihood of losing the house.

"If you have refinanced, you are more than doubly likely to ultimately end up trying to sell or default," Fujitsu's Martin North says. "Refinancing is not the silver bullet."

A recent examination by the Australian Securities and Investment Commission into refinancing transactions found the extreme fringe of the broking industry is involved in predatory lending or equity-stripping.

"Equity-stripping, asset lending, there are so many names you could [call it] but it's all about [lenders] managing risk on the base of what you can see to recoup your loan, rather than the needs and means of the person you're lending to," says David Tennant of Care ACT. "There is a need to revisit questions about how lenders assess what's affordable for people, matching the credit being offered to people's needs and means."

A Wizard Home Loans-Fujitsu joint report into predatory home loan lending from last September estimated that 50,000 Australian households fell victim to predatory lending practices in the preceding year. Of these, the group most commonly preyed upon was disadvantaged women at the city fringes. As it stands, the commission-based structure of the industry is an incentive for brokers to push loans on people whether or not they can afford them. And the bigger the loan, the more they earn.

Carolyn Bond, the chief executive of the Consumer Action Law Centre, says this causes problems when a person who is in trouble goes to a broker for a solution.

"They're able to give you advice on getting a loan," she says. "But there's not money in it for them to say, for example, 'It looks to me as if you're going to get yourself in more trouble, maybe you need to just sell your home. If you can't afford this mortgage, you probably can't afford another one."'

North says: "Brokers are under no obligation to provide the best advice to consumers. Our research highlights the fact that quite a few brokers will take into consideration the commission structure they may receive from the lender. You might think you're getting independent advice but what you're actually getting is what the broker thinks is best for them. Consumers [share] responsibility too, because ultimately they sign the paper. [But] are they adequately informed and is there enough competition in the industry to ensure they get the best outcome that is possible?"

State governments have agreed that stronger regulation is necessary. Currently in draft form, the new uniform mortgage broking laws would put the onus on the broker to assess the borrower's ability to pay, rather than simply relying on their asset value.

Regulating the mortgage broking sector in Britain effectively halved the number of brokers. "In Britain there's now about 10,000 brokers for a population of 55 million," North says. "In Australia we have 10,000 brokers for a population of 20 million. That tells me we have too many brokers."

Anatomy of a mortgage default

Roger Mendelson, the head of debt collection company Prushka, says banks are now taking a harder line with defaults and are serving orders for possession and sale of property more quickly.

In standard mortgage documents, borrowers are typically in default a mere 14 days after missing a single payment. On top of that, the bank may impose penalty interest of a minimum 5 per cent on top of the existing rate from that point, which can add to the borrower's precarious position.

"From the point of view of the borrower, it's not something you can just put your head in the sand and hope it goes away," Mendelson says, "because it definitely won't."

The process works like this:

* Once the borrower is in arrears, the bank's asset management division takes over from customer care.

* If the borrower is not in a position to pay, the bank will look to sell the property.

* The lender may let the borrower sell the property privately but in some cases it may obtain an Order for Possession from the State Supreme Court. Borrowers have no defence if they are in arrears.

* As soon as the borrower receives official notice of default, the loan incurs a penalty interest rate of at least 5 per cent above the original rate, which continues to mount until the property is sold - further eroding any equity left in the home.

* Once the bank has the order for possession, it can order the Sheriff to forcibly remove the borrower and their belongings if they haven't left by the due date.

* The borrower is then liable for all costs incurred by the bank, including legal fees, cleaning fees and agent expenses, as well as the penalty interest on the loan.

* Bankruptcy usually follows if the borrower can't pay these expenses.

If you risk falling into arrears, Prushka recommends you seek advice from a financial counsellor and present your lender with a payment plan. It says you are better off with a bank than with a non-bank lender because non-bank lenders generally move to sell up more quickly and banks are obliged to work with you to find a solution before they force a sale (see box page 6).

If the default process begins, attempt to control the sale yourself rather than allow the lender to. List the property for sale and inform the lender.

Source: Prushka

One family's debt story

The back pages of local papers are filled with ads for mortgage brokers promising to save your home. It was there that one family from Sydney's western suburbs turned when they got into difficulty - but it cost thousands and made things much worse.

The couple fell into arrears when John* lost his overtime. He and his wife Kay* owed $276,000 to a bank.

The major banks are members of the Banking Ombudsman dispute resolution scheme and are obliged under it to work with borrowers in hardship to give them temporary relief.

Without telling them about lenders' obligations for hardship provisions, the bank served them with court papers.

In a desperate panic about losing their home, they found a refinancer in the back pages of their paper in February 2006. They borrowed $315,000 to cover the higher-priced loan, the broker's fees of $9000 and two sets of solicitors' fees at a total of $7500.

The new interest rate was a punishing 14 per cent, with an interest-only period of one year.

But they realised they had been ripped off and late last year went to refinance again through another lender.

It was only after moving to the third lender that they went to see financial counsellor Katherine Lane at the Consumer Credit Legal Centre of NSW, who informed them about the hardship provisions. They are now trying to arrange a payment variation on the grounds of hardship through the NSW Office of Fair Trading.

"The upshot is it would have been a lot better if the first lender had made an arrangement rather than taken them to court," Lane says.

"Because all they've done is refinance several times and massively increased their debt."

The problem is, Lane says, "[the banks] don't have to tell you about hardship negotiation and once they commence proceedings, you can't go to the Ombudsman.

"Their story is a warning: don't refinance in desperation," she says. "Lenders also need to be a lot more willing to work with people to sort out difficulties."

Names have been changed.

Anatomy of mortgage stress

MILD STRESS

Cut back on spending

Use credit for fund repayments

Increase number of cards

Refinance

SEVERE STRESS

Delay mortgage payments

Refinance to specialist lender

Receive default notice

Receive demand notice

Put property on market

Foreclosure

Bankruptcy

SOURCE: FUJITSU CONSULTING