Counting the cost of mortgage holidays
Mortgage holidays may sound like a great idea, but as usual "all that glistens is not gold".
Sunday, August 8th 1999, 12:00AM
by Paul McBeth
Mortgage holidays may sound like a great idea, but as usual "all that glisters is not gold".
Accounting firm Spicer & Oppenheim, in its latest newsletter to Wellington clients, points out that even a brief break from paying interest can have a huge impact. The trap is that you're effectively increasing the size of your original loan - and paying interest on the interest.
"In an extreme example, with a 20 year loan with an interest rate of eight per cent, each week of a mortgage holiday will increase the term of the original loan by five weeks, " Spicer says.
"So a ten week holiday increases the term by nearly a year, with consequential additional interest costs!"
What exactly are mortgage holidays?
On some loans, mortgage lenders will give you the option to 'take a break' from paying interest for a limited period. This can sound very attractive if you've had some unexpected expenses, you're between jobs or perhaps you've been off work through sickness or injury.
Arranging this is pretty straightforward. Some lenders offer this service for free, and they mostly have enough security in place to cover their risk so they won't need extra paperwork.
But it can cost more than you think
The term of your loan increases by more than the length of your mortgage holiday (unless you increase your loan repayments to compensate) and the total interest you repay will increase as well.
Why? All the interest that you don't pay for the time you're on holiday gets added to the amount you still owe to. So when you start your mortgage repayments up again, you have to pay interest on amount you owe plus that extra interest.
As Spicers puts it, "it is helpful to think of a mortgage holiday as a new loan for an increased principal that comprises the original loan and the interest that accumulates during the holiday". And you only have to look at their examples to see that it can be a fairly expensive holiday too.
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Financial consultant and author Martin Hawes recommends that, at the very least, you should ask your mortgage lender to calculate the true cost of your loan holiday so you can make an informed decision on whether you really need it. Good Returns will be interviewing Martin this Wednesday about his latest book, Five ways to save more money on your mortgage. If you have any questions you'd like to ask him, please email them to me (click my name below).
Many thanks, Ann Cunninghame