What is the impact of taking a mortgage holiday?

What is the impact of taking a mortgage holiday?

Many Aussie banks are offering to freeze mortgages as part of their coronavirus relief packages, meaning many mortgage holders who have been financially affected by COVID-19 are looking forward to hitting “pause” on their mortgage payments for a few months.

But could taking a holiday from your home loan do more harm than good? What are the long-term financial consequences of putting a temporary freeze on your mortgage payments?

What exactly is a mortgage holiday?

Also known as a repayment holiday or a mortgage freeze, a mortgage holiday is when your bank allows you to pause repayments on your home loan for a limited period of time. 

Mortgage holidays often have maximum terms of 3 to 6 months, though it may be possible to extend a holiday for as long as 12 months.

A bank may offer a repayment holiday as an option to borrowers who are out of work and unable to afford their full repayments for a long period of time, such as when they lose their job, go onto parental or maternity leave, or need to recover from illness or injury.

You may also need to pay a fee to apply for a mortgage holiday.

How does a mortgage holiday work?

When you successfully apply for a mortgage holiday, you may be able to switch to interest-only payments (relieving some pressure on your budget), or halt your mortgage payments altogether for a limited time.  

Even if you totally freeze your mortgage payments, many banks will still charge interest on your home loan during this time. This interest is often capitalised, meaning the charges will be added to the total loan principal you owe, and interest will be charged on your interest. This means you’ll finish your payment holiday owing more money on your mortgage than you started.

Once your repayment holiday ends, you may need to make higher loan repayments to help pay off this higher balance plus interest over your original remaining loan term.

Alternatively, your lender may let you extend your loan term, often by the same length as your original repayment holiday. You’ll still need to increase your minimum repayments to pay off the extra balance plus interest, but not by quite as much, which might be a little easier on your budget.

  • Looking for a mortgage that offers more flexibility? Contact a home loan expert to learn more about refinancing and other options.

Does a mortgage holiday save me money?

Yes and no.

In the short term, not having to pay your mortgage can be an enormous relief on your household budget. This can important if you’re experiencing financial distress and need to get back on your feet.

In the long term, taking a mortgage holiday may make your loan more expensive overall, due to interest capitalisation. Afterwards, you may need to make higher repayments, putting pressure back on the household budget, or extend your loan term, meaning you may be charged even MORE interest.

Before you apply for a mortgage holiday, it’s important to think about the impact it could have on your finances, and what this could mean for you and your household. If you’re unsure, consider contacting a financial adviser for advice.

How much could a mortgage holiday cost me?

Let’s look at a hypothetical example (for illustrative purposes only - does not include fees or changes to interest rates over time):

Imagine that a year ago, you’d taken out a 30 year mortgage for $400,000 with an interest rate of 3.5 per cent.

After making monthly principal and interest repayments of $1,796.18 for 12 months, your workplace shuts down and your lose your job.

You contact your bank and successfully apply for a six-month repayment holiday. 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. 

However, during your six-month repayment holiday, $6,915.92 in interest charges are added to your mortgage. Before your repayment holiday, you owed $392,323.49 on your mortgage, but afterwards you owe $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.

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How do I calculate monthly mortgage repayments?

Work out your mortgage repayments using a home loan calculator that takes into account your deposit size, property value and interest rate. This is divided by the loan term you choose (for example, there are 360 months in a 30-year mortgage) to determine the monthly repayments over this time frame.

Over the course of your loan, your monthly repayment amount will be affected by changes to your interest rate, plus any circumstances where you opt to pay interest-only for a period of time, instead of principal and interest.

How long should I have my mortgage for?

The standard length of a mortgage is between 25-30 years however they can be as long as 40 years and as few as one. There is a benefit to having a shorter mortgage as the faster you pay off the amount you owe, the less you’ll pay your bank in interest.

Of course, shorter mortgages will require higher monthly payments so plug the numbers into a mortgage calculator to find out how many years you can potentially shave off your budget.

For example monthly repayments on a $500,000 over 25 years with an interest rate of 5% are $2923. On the same loan with the same interest rate over 30 years repayments would be $2684 a month. At first blush, the 30 year mortgage sounds great with significantly lower monthly repayments but remember, stretching your loan out by an extra five years will see you hand over $89,396 in interest repayments to your bank.

Mortgage Calculator, Loan Term

How long you wish to take to pay off your loan. 

Mortgage Calculator, Repayment Type

Will you pay off the amount you borrowed + interest or just the interest for a period?

What does going guarantor' mean?

Going guarantor means a person offers up the equity in their home as security for your loan. This is a serious commitment which can have major repercussions if the person is not able to make their repayments and defaults on their loan. In this scenario, the bank will legally be able to the guarantor until the debt is settled.

Not everyone can be a guarantor. Lenders will generally only allow immediate family members to act as a guarantor but this can sometimes be stretched to include extended family depending on the circumstances.

What is breach of contract?

A failure to follow all or part of a contract or breaking the conditions of a contract without any legal excuse. A breach of contract can be material, minor, actual or anticipatory, depending on the severity of the breaches and their material impact.

What happens to your mortgage when you die?

There is no hard and fast answer to what will happen to your mortgage when you die as it is largely dependent on what you have set out in your mortgage agreement, your will (if you have one), other assets you may have and if you have insurance. If you have co-signed the mortgage with another person that person will become responsible for the remaining debt when you die.

If the mortgage is in your name only the house will be sold by the bank to cover the remaining debt and your nominated air will receive the remaining sum if there is a difference. If there is a turn in the market and the sale of your house won’t cover the remaining debt the case may go to court and the difference may have to be covered by the sale of other assets.  

If you have a life insurance policy your family may be able to use some of the lump sum payment from this to pay down the remaining mortgage debt. Alternatively, your lender may provide some form of mortgage protection that could assist your family in making repayments following your passing.

Who offers 40 year mortgages?

Home loans spanning 40 years are offered by select lenders, though the loan period is much longer than a standard 30-year home loan. You're more likely to find a maximum of 35 years, such as is the case with Teacher’s Mutual Bank

Currently, 40 year home loan lenders in Australia include AlphaBeta Money, BCU, G&C Mutual Bank, Pepper, and Sydney Mutual Bank.

Even though these lengthier loans 35 to 40 year loans do exist on the market, they are not overwhelmingly popular, as the extra interest you pay compared to a 30-year loan can be over $100,000 or more.

Mortgage Calculator, Deposit

The proportion you have already saved to go towards your home. 

What is a construction loan?

A construction loan is loan taken out for the purpose of building or substantially renovating a residential property. Under this type of loan, the funds are released in stages when certain milestones in the construction process are reached. Once the building is complete, the loan will revert to a standard principal and interest mortgage.

What is appreciation or depreciation of property?

The increase or decrease in the value of a property due to factors including inflation, demand and political stability.

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An estimate of how much your desired property is worth. 

Why should you trust Real Time Ratings?

Real Time Ratings™ was conceived by a team of data experts who have been analysing trends and behaviour in the home loan market for more than a decade. It was designed purely to meet the evolving needs of home loan customers who wish to merge low cost with flexible features quickly. We believe it fills a glaring gap in the market by frequently re-rating loan products based on the changes lenders make daily.

Real Time Ratings™ is a new idea and will change over time to match the frequently-evolving demands of the market. Some things won’t change though – it will always rate all relevent products in our database and will not be influenced by advertising.

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