Applying for a home loan is necessary for many people who want to own a home. However, it is also a long-term financial commitment that could last for up to 30 years – a very long time during which your personal circumstances may sometimes change.
You may want to take a sabbatical to study or travel and not have a mortgage repayment looming on your head at this time. Illness, loss of a job, or any personal loss can also make it challenging to work for some time, affecting your ability to service a mortgage. What can you do in such a situation?
Depending on your lender and your circumstances, you may be able to apply for a repayment holiday that lets you temporarily pause your mortgage repayments. A mortgage repayment holiday could range from a couple of months to up to a year with some lenders.
During this period, you can switch to making interest-only repayments instead of paying the full repayment amount. Alternatively, some lenders may not require you to make any mortgage repayments, but interest will generally continue to accrue on your loan.
Who is eligible for a mortgage repayment holiday?
Not every lender offers a repayment holiday, and those who do will not approve everybody for it.
If you think you can’t afford your repayments for some time because you need to focus on something else, you can check whether your lender offers a mortgage repayment holiday. However, there’s no guarantee your application will be approved. A lender will consider many things before deciding on your application. Most importantly, you’ll need a good credit score, no default on your home loan, and a loan-to-value ratio of less than 80%.
How long you’ve held the loan with the bank could also be a criterion. Typically, the home loan should have been with the bank for at least a year before you can apply for a repayment holiday.
What is the actual cost of a mortgage repayment holiday?
A mortgage repayment holiday may seem like a convenient option to manage your cash flow, but there are traps you should know about.
Not having to make any repayments for a short period can free up your household budget considerably. This could be helpful if you’re unable to work or facing some financial pressure. However, in the long run, a mortgage holiday can make your loan more expensive due to interest capitalisation.
Here’s a small example to help you understand this. Let’s say you have $200,000 outstanding on your mortgage and decide to take a repayment holiday for a year. During the next 12 months, you don’t need to pay anything to the lender. However, your loan will continue to accrue interest which will keep getting added to your home loan balance. This is also known as interest capitalisation.
For simplicity of calculation, let’s assume the total interest payable on your loan during the year is $10,000. It means at the end of your repayment holiday, you’ll owe the lender $210,000 instead of your original loan balance of $200,000.
After the repayment holiday, your lender could increase your monthly repayment to clear the increased balance over the original term. This may put additional pressure on your household budget. Or, the lender may allow you to extend your loan term to pay off the increased balance. However, stretching the loan term would see you paying interest over a longer duration, adding to the total interest you pay across the life of the loan.
Before applying for a mortgage holiday, it’s important to understand its impact on your finances to ensure you don’t end up financially worse. You could also consider the following alternatives to ease your financial situation without altering your mortgage repayments.
- Loan redraw facility – If you’ve made some additional repayments on your loan, you could withdraw those funds using a loan redraw facility and use them to make future repayments.
- Using the balance in your offset account – Your offset account balance helps to reduce the interest you pay on your loan. However, if you’re running short of funds, you could take out money from your offset account and use it to manage your finances.
- Look for a lower interest rate – If you’re looking for a more permanent way to ease your monthly budget, you could discuss the possibility of switching to a lower interest rate with your lender.
Lenders typically offer lower rates to new customers, and you could use this knowledge to negotiate a better rate. Alternatively, you could consider refinancing with another lender offering a lower rate, but you’ll likely need to pay some fees for switching. You could connect with a mortgage broker to find suitable deals and understand the costs of refinancing your mortgage.
If none of these alternatives seem feasible, a repayment holiday could help you manage a temporary cash shortfall without defaulting on your home loan. However, it could also increase the cost of the loan to you. Make sure you consider the increased costs before availing of this option to ensure you can manage your repayments at the end of the holiday period. You could also consider speaking to a financial counsellor to learn about ways to manage your money better.
