The Real Truth about Payment Breaks
13 May 2020
As people deal with the financial impact of Covid-19, there has been talk about loan repayment breaks or payment ‘holidays'. Is a payment break really a 'holiday'? What are the financial implications? In this blog post, we explore what the real cost to the consumer might be.
A person taking a summer holiday might take the opportunity to relax and forget about the world for a while. It might be a simple pleasure of having an extra croissant in the morning. Or choosing the dessert after dinner. Or having a couple of glasses of wine in the evening. Down time is important. It often helps us to recharge the batteries and squeeze a little bit of extra enjoyment out of life.
We generally accept that this change in our behaviour will come at a cost. Those jeans might be a little tighter when you get home. The next session in the gym might feel that little bit tougher. As well as your physical fitness, your financial fitness might also suffer in the short term.
In recent weeks, there has been a lot of discussion about payment breaks or payment holidays. There has been talk about blanket deals for borrowers during the Covid-19 outbreak. There have been suggestions that such deals are an ideal solution for anyone with a loan or a mortgage. Amidst all of this talk, the cost to the consumer has frequently been ignored.
To be very clear, a payment break or ‘holiday’ comes at a significant cost. It might offer flexibility in the short term, but a payment break will cost the borrower more in the long term. Any borrower entering into this type of arrangement must be aware of the financial implications and there is a clear duty on every financial institution to explain the details in simple terms.
Let’s look at two examples to highlight what the cost might be.
Personal Loan Payment Break
Let’s start by looking at a €10,000 personal loan repayable over five years at an interest rate of 10%. The borrower takes a three-month payment break and then increases their monthly repayment. This enables the borrower to pay off the loan within the agreed five-year period. By the end of the loan, this payment break will have cost the borrower an extra €170 or so in interest.
Mortgage Payment Break
For a mortgage, the costs are much higher. This is due to the typical value and duration of a mortgage. Let’s look at a mortgage of €250,000 at a rate of 4.5% over 25 years. The borrower takes a three-month payment break and then increases their monthly repayments. By doing this, the mortgage holder can pay off the mortgage within the agreed term. By the end of the mortgage, the borrower will end up paying €2,700 more over the lifetime of the mortgage.
For borrowers who are unable to make their loan or mortgage repayments, a payment break may be critical. However, it is vital that this isn’t presented to borrowers as a one size fits all solution. The person’s individual circumstances must be carefully considered.
Credit unions are taking a personal approach to helping members who are struggling at this time. Credit union staff are happy to take the time to listen to the member’s situation. They will work out how the person is coping and the financial impact of their changed circumstances.
It might be that the person can continue to make payments in the short term. It might be that a reduced payment is necessary. It might be that a payment break is the only option.
If a payment break does turn out to be the best option, credit unions will not try to disguise it as a free holiday. They will take their time with the member to ensure the person understands and is comfortable with the revised plan.
The very least people deserve from their financial institution is empathy, honesty and respect. Credit unions will not claim to have all of the answers. But being open and honest with members is a great starting point.