The true cost of a ‘repayment holiday’
In life, ‘there aint no such thing as a free lunch’. Recorded uses of this phrase have been around since the early 20th century and this adage continues to ring true today.
In the era of Covid-19 we have seen many healthy businesses and good employees dealt a knockout blow through no fault of their own. Strict health related measures handed down by various levels of government have reduced strong & thriving workplaces to dust. Landlords who had taken risks and expanded their portfolios have likewise seen their incomes dry right up.
The olive branch has been extended firmly by governments to assist affected parties through, although there will be a long-term cost on society. Financial institutions have also stepped up with a raft of measures to ensure that borrowers are not forced to liquidate their assets, at least for the next 6 months.
A key offer from lenders is the ‘repayment holiday’ whereby (if approved) a borrower is not required to make loan repayments for up to 6 months. The loan does keep accruing interest and fees. You can rest assured all costs will be added to the facility and need to be repaid over the remainder of the loan term.
This is the financial equivalent of a traffic jam. The meter is running, but you’re not going anywhere.
We fully understand that some customers need to take up the holiday due to very tight cash flow restrictions. Others who have some reserves will be able to keep up repayments and be much better off financially once we emerge out of this crisis.
For the purpose of an example we have presented below a summary of 3 scenarios:
This is based on a mortgage of $400,000 over a 30-year (360 months) term at 2.74% rate with principal & interest (P&I) repayments. The monthly repayment quoted is after the initial 6 months to ensure accuracy.
Continue normal P&I repayments
- $1,631 minimum monthly payment
Take first 6 months Interest Only (IO) and then resume P&I
- $1,648 minimum monthly payment
- $1,987 more expensive over life of loan
Take first 6 months as a repayment holiday and then resume P&I
- $1,689 minimum monthly payment
- $10,809 more expensive over life of loan
The comparison assumes that rates remain unchanged for the life of the loan and only minimum repayments are made. We note that some lenders have announced rebating the ‘interest charged on interest’ during the repayment holiday. If factored in, this would slightly reduce the cost over the life of the loan.
If you are forced to take a repayment holiday there is no shame in this and we have assurance from legislators that it will not effect your credit record adversely.
There are a few simple strategies that you can employ to ‘catch-up’ and reduce the interest you pay over the remaining life of your loan.
1. Make extra repayments.
There are many ways to pay more off your loan. They include lump sum payments, rounding up of your required regular payment above the minimum, or changing your frequency of repayment from monthly to weekly or fortnightly. All these factors help you minimise the interest you pay by clearing more principal than the bank requires.
2. Have your Broker review your loan periodically.
As your trusted Broker, we have access to over 30 lenders and can reprice existing loans. We suggest asking your broker to reprice your variable loans with your existing financial institution every couple of years to ensure you remain on a competitive deal. If your lender won’t compete, then you can vote with your feet and we can facilitate a refinance to a better deal.
3. Utilise a 100% offset account or redraw.
Although offset products generally come with an annual fee, sometimes you have funds lying around that are earning you very little interest in a savings account. By using an offset account, you could be saving interest, instead of earning very little interest and then paying tax on those earnings.
Redraw can be activated on most variable rate loans and gives you the ability to voluntarily pay extra off your loan and then ‘redraw’ those additional repayments in times of need. Redraw is usually available at no extra cost online.
I urge all Australians that find themselves in a difficult position to reach out to your local Mortgage Broker for assistance. Your Broker will generally have a huge amount of experience and is passionate about ensuring your best interests are served to the life of your loan.
We exist to keep the banks honest and more money in your pocket.
Stay safe out there.
Michael Arbon – Mortgage Broker
p. 0428 873 008