The ‘cheapest’ way to finance a payment holiday

Woman managing bills. Image: iStock

It is not as simple as skipping three payments and then adding three.

Many South Africans are requesting or taking up banks’ offers of a three-month payment holiday on their debt (and in some cases, banks are requesting customers in certain segments to opt out of these).

A payment holiday is not a solution for everyone, however. Small business owners would typically require significantly more help from their banks. But, in the case of salaried individuals who have been forced to take a pay cut, or have lost out on commission they would normally earn (or overtime traditionally worked), it is likely a very sensible course of action (along with cuts in unnecessary expenses) until things return to normal.

For payment holidays, the default plan across most banks is that interest and standard monthly administration fees will still accrue for April, May and June and that the term remaining on the loan in question will be extended. Sounds simple enough. But, the extension on the term of the loan is almost always not three months. This is an easy incorrect assumption to make.

On short-term debt, like a personal loan, or one with a relatively short remaining repayment period, the impact of the accrued interest and the term extension is not that significant. It could still require a fourth (or fifth) month’s payment to cover the additional interest.

On long-term debt like a home loan, however, you will end up paying significantly more by simply taking up the offer of a payment holiday and extending the term. Here, the term extension could easily be closer to a year (!) than to three months, given that the monthly repayment would need to remain the same.

FNB, perhaps uniquely among banks, is promoting a Cashflow Relief Plan instead of a straight term extension. Simply, this is a separate ring-fenced loan used by the bank to cover the repayments due over these three months. Repayment will start once the relief period is over.

Doret Jooste, CEO of FNB Retail Money Management says, “The solution is designed to be less expensive compared to the traditional payment break with a term extension, where a customer could potentially be paying ‘interest upon interest’, fees are still levied during the break and their repayments on the longer term will be based on the conditions of the existing agreement, for example interest rate and fees. In the long-term, the total cost of credit for a payment holiday with a term extension is significantly higher than a cashflow relief plan.”

Home Loan Balance (31 March) R1 000 000
Rate 7%
Remaining number of payments 204
Monthly payment/instalment (R8 397) (R8 544)* (R8 397)
Payment Break – number of months 3 3 3 (bank pays via Cashflow Relief Plan)
Balance after Payment Break R1 017 602 R1 017 602 R992 265
New remaining number of payments after Payment Break 212 201 201
Extra payments needed i.e. number of months added due to term extension 8 0 0
Additional cost of credit paid due to term extension R59 019 R30 151 R0
Customer pays a total of (on underlying agreement) R1 771 926 R1 743 059 R1 687 718
Balance on Cashflow Relief Plan after payment break (R25 190)
Rate on Cashflow Relief Plan** 7.75%
Term*** 60
Monthly Premium, i.e. payment on Cashflow Relief Plan (R508)
Additional cost of credit paid due to Credit Relief Plan R5 275
Total paid by customer on Cashflow Relief Plan R30 465
Total paid (underlying agreement + Cashflow Relief Plan) R1 718 183
Savings to client vs term extension R28 867 R53 743

* Recalculated amount post payment break

** Prime rate charged on Cashflow Relief Plan

*** Flexible period, no penalties on early settlement

From the indicative comparison above, it is clear that a default term extension is not the most efficient way to fund a payment break. Using a ring-fenced cashflow loan on a home loan with R1 million outstanding over another 17 years (at an interest rate of 7%) would save this hypothetical customer nearly R54 000. If they manage to settle the ringfenced cashflow loan quicker, this saving will be higher still. It must be noted that they’re not really doing anything fundamentally different – they are still utilising a payment break but are simply funding it in another way. (Of course, they would be taking out an additional loan to do so.)

A further alternative (largely being downplayed by the banks) is to apply for a payment break but fund it by keeping the remaining term of the underlying agreement the same. So, on the home loan example, this customer would enjoy the payment break but would spread the balance over the remaining term. This would translate to a modest ±R150 a month increase on their payment.

What this comparison shows is that consumers taking up these offers need to understand the impact of what they are signing up for. If you are unsure, ask your bank

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