The true cost of a month's mortgage payment holiday
When money is tight, find out why a break from your mortgage repayments isn't always the ideal solution.
If your finances are getting a bit overstretched, you may assume that taking a break from your mortgage payments would help. But beware. It could cost you more than you think.
What is a mortgage payment holiday?
A mortgage payment holiday means your lender will let you off your repayments temporarily, reducing your monthly outgoings and giving you some valuable breathing space. You might ask for a holiday when you're faced with unexpected expenditure, or perhaps when you change your job, you are made redundant, take a career break or go on maternity leave.
That sounds great in theory, but there are certain rules on when you can apply, how long the holiday will last and, most importantly, how much extra it will cost you.
But before we look at that, it's important to know that not all lenders offer payment holidays.
Where payment holidays are available they vary greatly from one to lender to another, but here are some typical conditions:
1. A payment holiday will always be temporary. How long the break lasts depends on the lender. Nationwide, for example, will allow borrowers a break of up to 12 months, whereas Halifax will allow no more than six months over the life of the mortgage.
2. You must have paid your mortgage for a minimum period of time before you can apply for a holiday. This usually ranges from six months to a year.
3. Some lenders will insist you are up-to-date with your repayments when you ask for a holiday. Other lenders may still grant you a holiday if you're in arrears as long as you haven't fallen too far behind. You might, for example, be allowed a break if you've missed no more than one payment.
4. You might not be able to take a holiday if your loan-to-value (that is your mortgage as a percentage of the value of your home) exceeds the lender's criteria.
5. Most importantly of all, interest will still accrue during the holiday and any missed interest payments will be added to your mortgage. This means your monthly payments will increase after the holiday has ended.
So, you can see taking a holiday isn't quite as easy as it sounds, and because interest continues to build up it can be expensive. What's more, by deferring your payments for a while you're actually pushing up your outstanding debt. This means there could be a greater risk of falling into negative equity, when you owe the lender more than your home is worth.
Bear in mind that negative equity is an even bigger threat when house prices are dropping fast as they are now.
How much does a payment holiday really cost?
Let's say your original mortgage is £150,000 over 25 years with an interest rate of 4.5%.
Your monthly repayments are £833 which you pay for the first 12 months. After this time you would have paid a total of £9,996 and reduced your outstanding mortgage to £146,677.
But you then decide to take a three month repayment holiday.
During the break your capital repayments are put on hold, but the interest you skip is added to the mortgage. This increases the capital amount you owe your lender. Each month you miss a payment the interest charged is higher because you're outstanding mortgage debt is getting bigger. This extra interest amounts to £1,656 over the three month holiday.
After the break, this amount is added on which takes your outstanding mortgage balance up to £148,333 (£146,677 + £1,656). So, your repayments will increase by £14 from £833 to £848 to make up for the shortfall over the remaining term.
An extra £14 a month may not sound like much, but imagine you paid that amount for the rest of the term (23 years and 9 months). Your total repayments will be run to £251,676 (£848 x 285 remaining repayments + £9,996 you have already paid in the first year before the payment break).
But if you had paid the mortgage steadily at £833 a month for the entire 25 year term as originally planned, the total cost would only be £249,900.
So, by taking a short payment holiday, you end up paying £1,776 extra. Blimey!
(Note the figures have been rounded and we've assumed the interest rate stays the same throughout the mortgage term.)
When should you take a payment holiday?
There's no question holidays come with a pretty hefty price tag, but a break from your payments may be sensible if the alternative is falling into arrears. If you're beginning to worry how you'll make your payments, then it's vital to speak to your lender as soon as possible.
Your lender may decide a holiday isn't appropriate for you and offer to help you in other ways. For example, it may allow you to make reduced payments for a while, rather than taking a total break. It might also be a good idea to look at other options, such as extending your mortgage term or switching to interest-only payments temporarily. All of these measures will push up the total amount of interest you will pay, but may prove cheaper or more suitable than a payment holiday.
Remember, your lender is under pressure from the regulator - the Financial Services Authority - to treat you fairly if you're in financial difficulty. So don't be afraid to speak up.
If you need help with your mortgage, speak to a lovemoney.com broker completely free of charge
This is a classic lovemoney article that has been updated