Applying for Financial Hardship as a Property Owner In A Covid-19 World

This article is current as of 1 September 2021

It’s Covid-19 lockdown déjà vu for New Zealand. While most of the country is now at level 3 Auckland will remain at level 4 for at least a few more weeks. The financial impact of lockdown is huge for some families; daily we hear heartbreaking stories of families and family businesses stretched beyond their limits. Much aroha to everyone facing financial hardship at this time.

During the first lockdown in 2020 the Reserve Bank and lenders responded quickly with mortgage repayment deferral packages. So far this time around the banks haven’t released any specific solutions for homeowners facing financial hardship due to Covid-19. If you find yourself unable to pay your mortgage you still have options; the difference is that last year the banks allowed you to apply for financial hardship with no impact to your record. Currently if you apply for financial hardship it will be flagged in your file and you may need to explain it in the short-mid term future if you apply for any sort of finance. But we hope that when banks assess applications in the future they are understanding towards those who have to apply for financial hardship now due to lockdown.

What are my financial 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, or
• apply for a mortgage holiday.

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 or when recovering from lockdown.
Impact if you don’t return to the previous (shorter) mortgage 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 over the lifetime of the mortgage. Most banks therefore limit how long you can extend the term of your mortgage. They may decide that for 3-6 months you can pay your mortgage at the 30 year rate. After that 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, assuming it is only for the short term. 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 in the example 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 typically only allow 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 it ultimately 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 deferral: This strategy is, unsurprisingly, the most expensive. Over just 3 months, not only have you added $4,000 to your mortgage but that $4,000 accrues interest over the remaining time on your mortgage.

Which financial hardship option should you choose?

Which financial hardship strategy you decide to go with comes down to how much money you need to free up to cover your expenses. We won't patronise you by saying cut back where you can, we know that when you're at the point of applying for financial hardship you're not getting take away coffees or going out for dinner. You're just trying to get by.

The key is to go for the cheapest solution that will still cover your costs.

Continuing the $500,000 mortgage example above, if your income had dropped by $1,000 you would consider either:

1. Extending the terms of your mortgage (ie from 20 years to 30 years). This would give you access to $700 per month, leaving you $300 short, or
2. Going to an interest-only mortgage for a period. This would free up $1,333 per month - covering your $1,000 shortfall with $333 left over each month. Ideally you would put the $333 aside to go back towards your mortgage at a later date.

So the important questions to ask yourself 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 to change my mortgage? ie; do you have cash savings that you could use before adding additional costs on to your mortgage?

You don't need to navigate all of this alone. Talk to your mortgage broker and they will help you decide what is right for you as well as deal with your bank.