Housing is one of the largest expenses faced by most households. To assist with this challenging time, the ‘Big Four’ banks (ANZ, BNZ, Westpac, and ASB), as well as some smaller banks and lenders, have announced that customers affected by Covid-19 can apply to go on a mortgage repayment holiday for three to six months.
However, this “holiday” might not be as good as it first sounds.
Repayment holidays can offer peace of mind - but are not a long-term solution. During your repayment period, the interest continues to accrue, and it is added to your home loan balance. This is also known as interest capitalisation. At the end of the “holiday” period, your home loan balance would have increased.
What is the true cost of the Mortgage Repayment Holiday?
Let’s look at a hypothetical example (for illustrative purposes only - does not include fees or changes to interest rates over time):
Let’ say you have a $400,000 mortgage, 30-year loan term, and an annual interest rate of 3.5% where you’re making a principal and interest monthly repayment of $1,796.18
After the first 12 months, your mortgage balance is now $392,323.49.
Now if you were to take a six-month repayment holiday, the interest rate during that period gets added (capitalised) to your home loan principal.
This makes $1,796.18 per month (or $10,777.08 in total) available in your household budget to help manage your other expenses during this time.
By the end of the six- month period, your new mortgage balance will be$399,239.41.
In order to pay this off over the remaining 28 years and 6 months of your loan term, your monthly repayments would need to increase to $1846.38. That’s just $50.21 more than it was before, but that leads to paying an extra $6,393.44 in total on your mortgage, compared to if you hadn’t taken the six-month repayment holiday.
Are there alternatives?
If you can afford to, the best bet is to avoid this “holiday”, but if not, check with our mortgage advisers to see what your options might be as there may be ways to reduce your regular mortgage payment without the drawbacks of a repayments holiday. Depending on your circumstances, a couple of examples of different solutions are below.
1. Moving to interest-only
Nearly all mortgage lenders offer borrowers the ability to make interest-only payments. This is usually capped at a certain timeframe, perhaps two years, but in this case, the banks are currently offering a six-month restructure without going through the full eligibility application (on a case by case basis). This means:
You still make regular repayments, but the amount of these reduce. An example: let’s say you have a $400,000 mortgage, 30-year loan term, and an annual interest rate of 3.5% where you’re making a principal and interest monthly repayment of $1,796.18 per month. By restructuring to interest only, your repayments will reduce by $629.48, and your new repayments will be $1166.70 per month. You will be paying interest on the outstanding loan balance but the good news is that balance does not go up like the loan repayment holiday does.
After the interest only period, you must change your loan back to principal and interest payments to reduce the principal owing.
This means you’ll pay more interest, as you aren’t reducing your principal for the agreed interest only period, but on the upside, this will still stop the overall sum owed from growing.
2. Extending the loan term
In this case you still make regular principal and interest repayments, but the amount of these reduce as the full loan term is extended. You’ll make more payments over a longer period.
You will pay more interest, as you take longer to pay off your loan.
Note that you can usually only extend your loan term if that loan term will stay under 30 years from your initial draw down or settlement date.
The bottom line
Not all banks and lenders have announced a Covid-19 specific repayment holiday package, but all lenders have financial hardship arrangements for customers facing financial difficulties during this time.
This is a tough time for many people, including those repaying a mortgage. It’d be our pleasure to discuss all your options with an initial complimentary and no-obligation chat.