Mortgage Hardships In A Covid-19 World

The banks are currently overwhelmed by hardship applications as a result of the Level 4 lockdown for Covid-19.  In this article we look at what your options are and why you would choose each option.

What are my hardship options during lockdown?

At most banks you have 3 options.  Ranked from the smallest impact to the greatest impact, these are:

• extend the terms of your mortgage
• change your mortgage to Interest Only
• apply for a mortgage holiday

Note: you can see our page with live updates on how each bank is handling hardships here.

What does it mean to extend the terms of your mortgage?

You may have started paying down your mortgage a while ago.  Let’s say you have only 20 years left on your $500,000 mortgage.  You’re probably paying around $2,823 per month.  If you were to extend this back to a 30 year mortgage, your payments would drop to $2,162 per month.

Outcome: You’ve freed up almost $700 per month to use during the lockdown.
Impact if you don’t return to the previous (shorter) term: The total interest on a $500k mortgage over 20 years is $677,600.  The total over 30 years is $778,500.  Extending your mortgage payments by 10 years means an additional $100,000 of interest.  Most banks are therefore limiting how long you can extend the term of your mortgage.  For 3-6 months you will pay your mortgage at the 30 year rate, and then your original payments will restart.
What is the impact of this strategy: This strategy has the least impact on the overall cost of your mortgage if you return to the original term of your mortgage.  In this example, for 3-6 months, you are paying $700 per month less off your mortgage than you would have.

What does it mean to change your mortgage to Interest Only?

As above, you have a $500,000 mortgage but this time you want to change your payments to Interest Only.  Your payments were $2,823 per month but on Interest Only, your payments are now $1,333 per month.

Outcome: You’ve freed up almost $1,500 per month to use during the lockdown.
Impact of Interest Only: these payments delay your mortgage from being paid down.  If you had 20 years left to go on your mortgage, you will still have 20 years at the end of the Interest Only payment period.  In the example above, a 6 month Interest Only period will have increased the cost of your mortgage by $8,940 (6 months of $1,490 Interest Only payments).

What does it mean to have a mortgage holiday (also known as a mortgage deferral)?

With a mortgage deferral, most commonly (and erroneously) known as a mortgage holiday, you are adding the interest payments to your mortgage.  We know that a $500,000 mortgage will have $1,333 per month of interest per month.  If you choose the mortgage deferral option, then after month 1, your total mortgage will be $501,333.  After month 2, your total mortgage would be $502,669.  After month 3, your total mortgage will be approximately $504,000.

Banks are concerned with this strategy as it can quickly build up to an unmanageable amount.  They are typically only allowing 3 months of mortgage deferral payments before you must start paying your mortgage back.  And, importantly, these payments will be at the original term of your mortgage.  So this mortgage was originally at $2,823 per month but after 3 months, the mortgage payments go up $2,846 per month.  This doesn't sound like much but the additional interest adds up to thousands of dollars of additional interest.

Outcome: You've freed up $2,823 per month of cash to use during the lockdown.
Impact of a mortgage holiday: This strategy is, unsurprisingly, the most expensive.  Over just 3 months, not only have you added $4,000 to your mortgage but this $4,000 accrues interest over the remaining time on your mortgage.

Which option should you choose?

Assume your income has reduced as a result of Covid-19.  Which strategy you decide to go with comes down to how much income you have lost?

In the example above, if your income had dropped by $1,000 you would either consider extending the terms of your mortgage (saving $700 per month, leaving you $300 short per month) or the Interest Only option (freeing up $1,333 per month and giving you an additional $333 to use for additional expenses).

So the important questions to ask are:

• how much has my income changed as a result of Covid-19?
• how long do I think I will have a reduced income (3 months, 6 months or longer)?
• when will I need money to pay my mortgage? ie; do you have cash savings that you could use before adding additional costs on to your mortgage?

Read our regularly updated article that breaks down what each bank is offering as hardship packages.