The Cost of Deferrals
With COVID-19 causing financial uncertainty for many Canadians, the Federal Government recently announced that all the big banks may be able to offer assistance to borrowers who currently have mortgages with them. The only thing is, there is no guidelines and everything is on a case by case basis right now.
What we've been hearing from people is that proof of employment being terminated or some kind of confirmation of lack of income needs to be shown. Lenders want people to know this is not an opportunity for borrowers to halt their mortgage payments and divert money into investments while still earning an income.
The other aspect of these proposed payment deferrals many people are not realizing is the cost of deferring. Again, there is no written guidelines or policies, but you can bet that all lenders are going to be adding the interest that is accumulating during the deferral period back on to your mortgage balance when payments resume.
If someone was in a 5-year fixed mortgage at 3% over a 25-year amortization, their monthly payments would be just under $1,420 a month for a $300,000 mortgage. The interest portion of this first payment would be little over $745 and the principal just under $675. Every month, these two amounts shift by approximately $2 so your 24th payment (2-year mark), would be just over $705 in interest and $714 in principal. If you were to defer your mortgage payments for 3 months (half of the maximum amount of time allowed), you would accumulate just over $2,106 in interest owing during those 3-months.
That $2,106 may need to be paid off in the remaining 33 months so that the balance outstanding at the end of your 5-year term is the same as it would of been if you did not take the deferral.
If that was split up equally over the remaining 33 months, that would mean an increase to your monthly payments after the deferrals by approximately $64 a month to cover the $2,106 in missing interest. However, if it was compounded on top of the outstanding balance, those payments will be even higher and that is how you get interest on top of interest. Those numbers are all going to depend on the lender and how they decide to calculate that balance.
What does this all mean?
For some, they may not have a choice and a deferal is their only option. For those looking to take advantage of a situation and potentially stop payments to divert money into investments, make sure you stop and think what it's actually going to cost. There has even been talks about credit histories potentially showing whether you required your mortgage to be deferred which may affect future borrowing potential.
If you have any questions for us please feel free to reach out at any time at the email link here.