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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Learn more about home loans

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.

Which mortgage is the best for me?

The best mortgage to suit your needs will vary depending on your individual circumstances. If you want to be mortgage free as soon as possible, consider taking out a mortgage with a shorter term, such as 25 years as opposed to 30 years, and make the highest possible mortgage repayments. You might also want to consider a loan with an offset facility to help reduce costs. Investors, on the other hand, might have different objectives so the choice of loan will differ.

Whether you decide on a fixed or variable interest rate will depend on your own preference for stability in repayment amounts, and flexibility when it comes to features.

If you do not have a deposit or will not be in a financial position to make large repayments right away you may wish to consider asking a parent to be a guarantor or looking at interest only loans. Again, which one of these options suits you best is reliant on many factors and you should seek professional advice if you are unsure which mortgage will suit you best.

What is an interest-only loan? How do I work out interest-only loan repayments?

An ‘interest-only’ loan is a loan where the borrower is only required to pay back the interest on the loan. Typically, banks will only let lenders do this for a fixed period of time – often five years – however some lenders will be happy to extend this.

Interest-only loans are popular with investors who aren’t keen on putting a lot of capital into their investment property. It is also a handy feature for people who need to reduce their mortgage repayments for a short period of time while they are travelling overseas, or taking time off to look after a new family member, for example.

While moving on to interest-only will make your monthly repayments cheaper, ultimately, you will end up paying your bank thousands of dollars extra in interest to make up for the time where you weren’t paying off the principal.

How much are repayments on a $250K mortgage?

The exact repayment amount for a $250,000 mortgage will be determined by several factors including your deposit size, interest rate and the type of loan. It is best to use a mortgage calculator to determine your actual repayment size.

For example, the monthly repayments on a $250,000 loan with a 5 per cent interest rate over 30 years will be $1342. For a loan of $300,000 on the same rate and loan term, the monthly repayments will be $1610 and for a $500,000 loan, the monthly repayments will be $2684.

Remaining loan term

The length of time it will take to pay off your current home loan, based on the currently-entered mortgage balance, monthly repayment and interest rate.

What is mortgage stress?

Mortgage stress is when you don’t have enough income to comfortably meet your monthly mortgage repayments and maintain your lifestyle. Many experts believe that mortgage stress starts when you are spending 30 per cent or more of your pre-tax income on mortgage repayments.

Mortgage stress can lead to people defaulting on their loans which can have serious long term repercussions.

The best way to avoid mortgage stress is to include at least a 2 – 3 per cent buffer in your estimated monthly repayments. If you could still make your monthly repayments comfortably at a rate of up to 8 or 9 per cent then you should be in good position to meet your obligations. If you think that a rate rise would leave you at a risk of defaulting on your loan, consider borrowing less money.

If you do find yourself in mortgage stress, talk to your bank about ways to potentially reduce your mortgage burden. Contacting a financial counsellor can also be a good idea. You can locate a free counselling service in your state by calling the national hotline: 1800 007 007 or visiting www.financialcounsellingaustralia.org.au.

What happens when you default on your mortgage?

A mortgage default occurs when you are 90 days or more behind on your mortgage repayments. Late repayments will often incur a late fee on top of the amount owed which will continue to gather interest along with the remaining principal amount.

If you do default on a mortgage repayment you should try and catch up in next month’s payment. If this isn’t possible, and missing payments is going to become a regular issue, you need to contact your lender as soon as possible to organise an alternative payment schedule and discuss further options.

You may also want to talk to a financial counsellor. 

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.

What percentage of income should my mortgage repayments be?

As a general rule, mortgage repayments should be less than 30 per cent of your pre-tax income to avoid falling into mortgage stress. When mortgage repayments exceed this amount it becomes hard to budget for other living expenses and your lifestyle quality may be diminished.

How can I calculate interest on my home loan?

You can calculate the total interest you will pay over the life of your loan by using a mortgage calculator. The calculator will estimate your repayments based on the amount you want to borrow, the interest rate, the length of your loan, whether you are an owner-occupier or an investor and whether you plan to pay ‘principal and interest’ or ‘interest-only’.

If you are buying a new home, the calculator will also help you work out how much you’ll need to pay in stamp duty and other related costs.

Mortgage Calculator, Loan Term

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

Will I have to pay lenders' mortgage insurance twice if I refinance?

If your deposit was less than 20 per cent of your property’s value when you took out your original loan, you may have paid lenders’ mortgage insurance (LMI) to cover the lender against the risk that you may default on your repayments. 

If you refinance to a new home loan, but still don’t have enough deposit and/or equity to provide 20 per cent security, you’ll need to pay for the lender’s LMI a second time. This could potentially add thousands or tens of thousands of dollars in upfront costs to your mortgage, so it’s important to consider whether the financial benefits of refinancing may be worth these costs.

What are extra repayments?

Additional payments to your home loan above the minimum monthly instalments, which can help to reduce the loan’s term and remaining payable interest.