Wish you didn’t have to pay your mortgage this month? There are services that can make this a reality – if you run into financial hardship or simply want to take a break from paying your mortgage, your lender may allow you to take a ‘mortgage vacation’. The concept sounds simple enough: you have the option of prepaying a certain amount of your mortgage, and then you can take a break from paying anything for a few months.
While it may sound good on paper, there’s a catch – interest still accrues during these months and is added to your total principal, which can cost thousands more in interest in the long run. Let’s take in-depth look at mortgage vacations and see if they are all they’re cracked up to be.
How Mortgage Vacations Work
Just like when you take a vacation from work, mortgage vacations require some planning ahead of time. Here’s an example of how to set one up:
If your mortgage payment is $1,500 per month and you want to skip your mortgage payments for four months while you go back to school, you’ll need to prepay an extra $6,000 ($1,500 X 4 months).
Let’s say you have a year until you want to go back to school – that means you’ll need to prepay an additional $500 per month ($6,000 / 12 months). This will increase your monthly mortgage payments to $2,000 ($1,500 + $500) until your mortgage vacation in a year’s time.
As we mentioned before, though, you’ll still be wracking up interest on your mortgage debt during your four months off – a lovely surprise that’s tacked onto your overall amortization.
The Marketing Tactics Used by Banks
In uncertain economic times, everyone needs some financial flexibility – after all, you never know when a financial emergency can strike – you can get laid off from work or become ill – that’s why it’s nice to have a backup plan.
While it can seem smart to cover your bases, the way banks market these options can be a bit misleading to consumers. For example, TD suggests you take an actual vacation with the savings you’d gain from not paying your mortgage – a way to fall back into debt and erase any savings you’d gain from your prepayments!
“To the uneducated consumer a mortgage payment vacation sounds like a great idea and it’s marketed in such a way that makes it look pretty inviting (who doesn’t love a good vacation?),” says Sean Schumacher, a mortgage agent at Safebridge Financial Group. “In reality, once you read the fine print you realize that by exercising this option it can potentially costs you thousands in extra interest over time.”
The Most Expensive Vacation You’ll Ever Take
Mortgage vacations may go by a variety of names, but the result is the same – you’ll end up paying more interest long-term on your mortgage.
“In the fine print, TD states: ‘Flexible Mortgage Payment Features will result in interest capitalization. That means the interest will be added back to the principal outstanding on your mortgage.’ You’re not missing a payment, the interest is added back on to your mortgage and amortized over 25 or more years, which can potentially double the amount owed on your payment ‘vacation,’” warns Schumacher.
Something else important to be aware of – while you can skip your mortgage payments, you’ll still be responsible for paying your mortgage insurance premiums and property tax.
Should You Ever Take A Mortgage Vacation?
Perhaps mortgage “vacations” should really be referred to as mortgage safety nets – they can provide temporary protection from defaulting on your payments, and that’s all they should be.
Keep in mind that it’s a loan – you cannot simply decide to skip your mortgage payment when you feel like it. You must get prior approval from you lender. Your lender has the right to refuse your request, especially if your credit rating has taken a beating.
“In my opinion, a payment vacation should only be used as a last resort when you’re unable to make your mortgage payments and only used with a strict repayment plan in place,” says Schumacher.
Alternative Savings or Prepayment Options
Rather than relying on a mortgage vacation (which your bank has the right to deny at its discretion), having an emergency fund is a far better idea. “I’ve always said at least three months savings, ideally six months in a high-interest savings account or your TFSA,” says Schumacher.
Instead of prepaying an extra $500 a month towards your mortgage, why not put that amount in your TFSA? Not only will this keep you out of debt, but you could save thousands over the life of your mortgage in additional interest.