April 6, 2020
Within days of the Government’s announcement that the country’s banks will be offering 6-month mortgage holidays, there’s been an avalanche of thousands of applications, and a rise in wait times.
Those that desperately need debt relief right now should absolutely be taking a mortgage holiday, but there are a few things you need to consider before you do. In brief: you need to be diagnosing your situation correctly to know that a mortgage holiday is the right decision for you, when is the right time to be making it and what it will cost you if you utilise it.
The reason caution is required is that the term mortgage ‘holiday’ is a bit of a misnomer - it would be more accurate to call it ‘Mortgage Repayment Deferral’ – terminology which some banks are now moving towards. While you won’t pay anything for the duration of the ‘holiday’ you will pay it back – and then some – further down the track. That’s because the interest you don’t pay during the mortgage holiday will be added to your mortgage, so you’ll end up paying interest on that interest, and your repayments afterwards will rise if the term of the loan remains unchanged.
So, given there is most definitely a cost to this decision (and the longer the holiday the greater that cost will be) it’s worth first establishing that you actually need one, and that you need it now. That comes down to accurately diagnosing your situation - are you in survival mode, do you need to stabilise and ensure you’re financially resilient for whatever lies ahead, or are you in a position to optimise your situation during this period?
That self-diagnosis has to start with some number crunch. So, do a budget that establishes: what are the absolute bare-bones essential costs you need to cover? What money do you have coming in? What reserves do you have, and how long will that last you?
If your income has evaporated and you’re unable to survive with whatever wage subsidy you’re entitled to despite zero discretionary spending, then you’re in survival mode and it would likely be appropriate for you to apply for a mortgage holiday. Ignore the fact it will cost you more in the long term – right now, reducing outgoings is your immediate priority.
If your income has been reduced due to Covid-19 and your debt servicing was quite high to start with, i.e. in normal times it takes up about 50% of your income or more, then the mortgage holiday is probably something you need to consider as well.
But if your cash flow isn’t that tight and you’re just in panic mode, it would be better if you didn’t use that holiday yet because you’d be putting higher costs onto your future self when you don’t actually need to.
For example, I’ve been working with a pilot whose job has obviously been severely impacted by Covid-19 and is likely to be for some time yet.
We ran their numbers and with some tweaks they could stretch their reserves to last for 33 weeks, so we determined that after 25 weeks, if there was no news of an imminent return to work, we’d then apply for the mortgage holiday.
The other thing you could consider is applying for an interest-only period. What this means is you continue to pay the interest bill on your mortgage, so what you owe doesn’t get any larger in the meantime, but you’re also not reducing the principal.
This could be effective for you if interest doesn’t account for the vast majority of your bill, while if you’re a recent home buyer it might not free up much cash,because you aren’t paying off much of the principal yet anyway.
Another option is to lengthen the term back out to 30 years, so you continue to pay a small bit of principal and continue to make some progress, just at a slower pace.
Hannah McQueen is an Authorised Financial Advisor, Chartered Accountant, Personal Finance Author and the founder of enableMe –Financial Personal Trainers.
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