NOTE: In light of the COVID-19 outbreak, many banks are giving mortgage customers the option to defer repayments for up to 6 months. If you are experiencing financial hardship as a result of the current crisis, get in touch with your bank for more information.
A mortgage is likely the biggest financial commitment the average Australian can expect to make. But personal circumstances are prone to change, and sometimes it can get difficult to keep up with things like monthly repayments. In these situations, many lenders will allow you to take a repayment holiday. Below, we take a look at what that means.
What is a repayment holiday?
Put simply, a repayment holiday is when you use ask your lender to temporarily suspend future repayments on your home loan.
It’s generally available to customers who need a break from their mortgage to focus on other commitments, such as travel, changing jobs, or taking maternity / paternity leave. However, not all lenders offer repayment holidays and the ones that do aren’t obligated to grant your request for one.
When assessing a request, lenders will look at how long you’ve had the loan and whether or not you’ve missed any payments. Your loan to value ratio will also be considered. If it exceeds 80% the matter will be turned over to your mortgage insurance provider.
What’s this about ‘interest capitalisation’?
While the name might suggest an unconditional break from your mortgage, repayment holidays are certainly not free. Throughout the holiday period, interest will continue to accrue on your loan. This is known as interest capitalisation.
Since your outstanding balance will have increased once the holiday period ends, your lender will opt to either extend your loan term or increase the size of your existing repayments.
So I wind up paying more?
That’s right. Though in such a low interest rate environment a few extra months’ worth of interest might not add up to much, especially when considered over the life of your loan.
Nonetheless, it pays to have a clear idea of how much a repayment holiday will cost you. Let’s consider the following example:
Harry is paying off a $300,000 loan over 25 years with an interest rate of 3.50% p.a. Assuming he’s five years into the loan, his balance currently sits at $269,091.
Harry decides to change careers and because he doesn’t want the stress of a mortgage hanging over him at this time, he requests a six-month repayment holiday from his bank.
In the first month of the repayment holiday, $785 in interest will be added to his outstanding balance, bringing it to $269,876. Interest is then charged on this amount in the second month, and so on.
|Month||Interest capitalised||Loan balance|
By the end of the six month repayment holiday, a total of $4,744 in interest will have been capitalised and Harry’s outstanding balance will have climbed up to $273,835.
At this point, how much more Harry will pay over the remaining 24 and half years will depend on what he and his bank decide to do with the loan term.
If he keeps the loan term the same and increases his monthly repayments, that extra interest will cost him a total of $4,055 over the life of the loan.
If, however, he extends the loan by six months to match the length of the holiday period, he’ll be looking at an extra $7,125 in costs over the full term.
What are some alternatives to taking a repayment holiday?
Redraw funds from your loan: If you’re ahead on your repayments, those funds can be retrieved via your home loan’s redraw facility and used to make future repayments.
Withdraw money from your offset account: An offset account is a helpful way to reduce the amount of interest you pay on your loan. But if your finances have taken a hit you might want to think about using those funds to tackle that problem.
Adjust your repayment amount: If you’re already paying more than the minimum repayment amount on your home loan, you should be able to ask your lender to reduce the size of your repayments.
Request a lower interest rate: You can also chat with your lender and find out if they are able to reduce your current interest rate. To boost your bargaining power, find out what your lender is currently offering new customers, or take a look at the home loan rates being offered by others on the market.
Refinance: If you’re paying more than you’d like to and your lender is unwilling to lower your interest rate, it might be time to consider refinancing to a cheaper home loan.
What if I’m experiencing financial hardship?
An unexpected turn of events - such as job loss, divorce, injury, or death of a loved one - can make it extremely difficult to keep up with your financial obligations.
In cases like these, your bank might be able to offer a temporary pause on your repayments to help you get back on your feet, whether you’re ahead on your loan or not. This is known as a hardship variation.
What counts as financial hardship?
Generally, someone is experiencing financial hardship if they have financial obligations they want to meet but are unable to do so. Some of the more common causes of financial hardship include:
- Injury or illness
- Decrease in income
- Relationship separation
- Domestic violence
- Gambling problems
If you’re experiencing any of the above, you should get in touch with your bank or lender as soon as possible so that a solution can be devised. There might be some initial embarrassment or awkwardness, but banks tend to be understanding, and will work with you to arrive at a solution that benefits everyone.