Many lenders have announced various assistance packages that include loan deferral arrangements for up to six months. Put simply, this means that mortgage holders who have been financially affected by COVID-19 are able to pause their mortgage payments for up to six months while they get back on their feet.
But could taking a holiday from your mortgage repayments end up doing more harm than good? What are the long-term financial consequences of putting a temporary freeze on your mortgage payments?
In many cases, while you’re taking a mortgage holiday, your interest charges will be capitalised, meaning they’ll be added onto the outstanding balance that you owe. At the end of the repayment holiday period, your lender may either
Increase your monthly mortgage repayments
Extend your loan term by the same length as your mortgage holiday to make up for the extra money you now owe.
For borrowers, it is important to read the fine print before taking up any of these arrangements. While taking a mortgage holiday could relieve pressure on your budget in the short term, you will likely end up paying more in total interest charges over the long term.
Let’s take a look at Restaurant Manager Tom, whose mortgage balance was $600 ,000 with an interest rate of 3.5% p.a. over 25 years.
Before the coronavirus pandemic, Tom’s minimum monthly repayments were $2,694 and he managed to get his home loan balance down to $580,000 over the first two years of his loan.
However, he has just lost his job and now needs to defer his mortgage repayments for six months so he doesn’t risk losing his house.
During this six month deferral, interest is still accruing onto the principal of his home loan balance. The interest that was charged in the first month then has interest charged on it during the second month, which has interest charged on it in the third month, and so on.
By the end of Tom’s six-month deferral, he now owes an extra $10,226 on top of his previous loan balance of $580,000. So Tom now owes $590,226
That may not sound like much, but because his loan term remains the same (he still has 23 years remaining on his loan) his monthly repayments will increase from $2,694 to $3,116 per month an extra $422 per month !!!
There may be other ways of freeing up some cash to help you over this period. Does your home loan have a redraw option or do you have a home loan offset account that you could draw some funds from?
Before picking up the phone and ringing your bank, schedule an online appointment with Ark Financial and we can complete a free home loan health check to work out what is the best option for you to take in your current circumstances.