What is the impact of taking a mortgage holiday?

Many Aussie banks are offering to freeze mortgages as part of their coronavirus relief packages, meaning many mortgage holders who have been financially affected by COVID-19 are looking forward to hitting “pause” on their mortgage payments for a few months.

But could taking a holiday from your home loan do more harm than good? What are the long-term financial consequences of putting a temporary freeze on your mortgage payments?

What exactly is a mortgage holiday?

Also known as a repayment holiday or a mortgage freeze, a mortgage holiday is when your bank allows you to pause repayments on your home loan for a limited period of time. 

Mortgage holidays often have maximum terms of 3 to 6 months, though it may be possible to extend a holiday for as long as 12 months.

A bank may offer a repayment holiday as an option to borrowers who are out of work and unable to afford their full repayments for a long period of time, such as when they lose their job, go onto parental or maternity leave, or need to recover from illness or injury.

You may also need to pay a fee to apply for a mortgage holiday.

How does a mortgage holiday work?

When you successfully apply for a mortgage holiday, you may be able to switch to interest-only payments (relieving some pressure on your budget), or halt your mortgage payments altogether for a limited time.  

Even if you totally freeze your mortgage payments, many banks will still charge interest on your home loan during this time. This interest is often capitalised, meaning the charges will be added to the total loan principal you owe, and interest will be charged on your interest. This means you’ll finish your payment holiday owing more money on your mortgage than you started.

Once your repayment holiday ends, you may need to make higher loan repayments to help pay off this higher balance plus interest over your original remaining loan term.

Alternatively, your lender may let you extend your loan term, often by the same length as your original repayment holiday. You’ll still need to increase your minimum repayments to pay off the extra balance plus interest, but not by quite as much, which might be a little easier on your budget.

• Looking for a mortgage that offers more flexibility? Contact a home loan expert to learn more about refinancing and other options.

Does a mortgage holiday save me money?

Yes and no.

In the short term, not having to pay your mortgage can be an enormous relief on your household budget. This can important if you’re experiencing financial distress and need to get back on your feet.

In the long term, taking a mortgage holiday may make your loan more expensive overall, due to interest capitalisation. Afterwards, you may need to make higher repayments, putting pressure back on the household budget, or extend your loan term, meaning you may be charged even MORE interest.

Before you apply for a mortgage holiday, it’s important to think about the impact it could have on your finances, and what this could mean for you and your household. If you’re unsure, consider contacting a financial adviser for advice.

How much could a mortgage holiday cost me?

Let’s look at a hypothetical example (for illustrative purposes only - does not include fees or changes to interest rates over time):

Imagine that a year ago, you’d taken out a 30 year mortgage for $400,000 with an interest rate of 3.5 per cent.

After making monthly principal and interest repayments of $1,796.18 for 12 months, your workplace shuts down and your lose your job.

You contact your bank and successfully apply for a six-month repayment holiday. This makes $1,796.18 per month (or $10,777.08 in total) available in your household budget to help manage your other expenses during this time. 

However, during your six-month repayment holiday, $6,915.92 in interest charges are added to your mortgage. Before your repayment holiday, you owed $392,323.49 on your mortgage, but afterwards you owe $399,239.41.

In order to pay this off over the remaining 28 years and 6 months of your loan term, your monthly repayments would need to increase to $1846.38. That’s just $50.21 more than it was before, but that leads to paying an extra $6,393.44 in total on your mortgage, compared to if you hadn’t taken the six-month repayment holiday.

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