The Government announced that banks will be able to provide a mortgage holiday of ‘principle and interest’ for the next 6 months to alleviate the consequences of COVID-19 on homeowners. However, there has been confusion amongst homeowners, landlords and tenants and the purpose of this article is to show how this would actually affect your cashflow over the full period of the lending.
Mortgage holidays can be a powerful tool when used correctly, and we will explore the math behind this. It’s particularly stressful to the business owners and employees who are suffering a substantial drop in income and that is what this is for. The purpose of the government offering this extra collateral is to avoid mortgage holders being in a position where they can no longer make their payments. This way homeowners can still keep their homes.
But its worth noting that banks are largely getting a free pass on this as well because the government is gauranteeing 80% of any loses they incur in their lending meaning the banks maximum loss is limited to 20% of the credit risk.
Banks must abide by the responsible lending code and discuss the negative implications of taking out a Mortgage Holiday. Our expectation is that banks will be releasing options to make this easier than under normal circumstances to apply for this and may even make exceptions to stretch the holiday over the remaining loan term. There are massive financial implications to taking out a Mortgage Holiday, so let’s look at the example below and 4 different scenarios.
We’ll use the NZ average house price of $640,000 as per February 2020 report from REINZ as an example with an 80% loan ($512,000) over a standard 30 years and an average 4% rate for the life of the loan for the sake of simplicity.
Scenario 1: Do not take out a mortgage holiday
Total Repayments = $879,372
Total Interest = $367,405
Repayment = $563.70/w
Scenario 2: Take 6 months Mortgage Holiday and repayments return to $563.70/w after the holiday
Total Repayments = $916,001
Total Interest = $403,668
Net Difference to Scenario 1 = $36,629
Extra time to repay your loan = 1 YR, 3M
Scenario 3: Take 6 months Mortgage Holiday and repay it over the remaining term of 29 years and 6 months
Total Repayments = $890,530
Total Interest = $377,941
Net Difference to Scenario 1 = $11,158
Repayments increase to $580.15/w post-holiday
It’s scary to note that under even this scenario the holiday will give you cashflow of $14,656 but costs you an additional $11,158 in interest, making the lending on the 6 months rent something like 76% interest on the benefit received.
Scenario 4: Take a 6 months Mortgage Holiday, repay within 2 years and finish the loan on the remaining 27 years 6 months
Total Repayments = $880,565
Total Interest = $368,048
Net Difference to scenario 1 = $629
Repayments increase to $712/w for a period of 2 years after the holiday and return to $563/w
Before considering a Mortgage Holiday consider using other alternatives first such as:
- Mortgage Repayment Reduction – Many borrowers are paying more than the minimum of their loan payments. Contact your bank directly to reduce these payments if you are paying above minimum and need the relief.
- Redraw Lines – If you have “Over paid” into your loan over the years or have equity in the house over and above the Loan to Value ratio your bank may allow you to have a redraw facility against that equity.
- Contingency Funds – Instead of accessing redraw lines or applying for mortgage holidays consider using your contingency funds (if available) in the interim.
- Interest-Only – If neither of the options above help, we recommend contacting your bank to set up your loans on interest-only for a short term (6 months). This will alleviate some of the principle payments, however once the I/O period expires your loan will have a slightly higher minimum payment as your pricipal balance wouldn’t have dropped, yet your loan term has shrunk.
- Mortgage Holiday – This is a last resort and is essentially a form of arranged arrears. It will provide massive immediate relief, however your interest will still accrue and your repayments would have a substantial increase immediately after the ‘holiday’. If you need this, apply directly with your respective bank.
If you absolutely need to take out a Mortgage Holiday, consider negotiating with your bank to be able to repay the arrears within a short time frame. This substantially reduces the overall cost of the exercise but comes with a cashflow risk once the holiday ends.
Under normal circumstances, Mortgage holidays have an impact on your credit score and future borrowing. Our expectation is that banks and credit agencies will be working closely with the government to ensure this won’t be the case to support their customers.
Seek financial advice at a time like this, your broker or adviser is sitting on their couch too and no doubt more than happy to assist.
Written by Steven Goodey from stevengoodey.com
and Eugene Bartsaikin from twineadvisers.co.nz