There’s one feature that some lenders offer with their mortgage products which we’ve never really discussed before. Lately, however, it seems like everywhere we look, more and more lenders are advertising it. Maybe it’s a sign of the times, since housing prices are at their highest, as well as household debt levels, and we could all use a little relief in the financial department of our lives. But this is one feature that might sound too good to be true: it’s the option to skip-a-payment and, while it could be helpful in times of financial duress, it comes with some consequences. Take a look at how it works, what it could cost you, and what to consider before making the decision to refrain from making one of your monthly mortgage payments.
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How does the skip-a-payment feature work?
Many of Canada’s mortgage providers offer products that allow homeowners to skip anywhere from 1 to 4 mortgage payments per year, without question. If you find yourself strapped for cash, this is obviously a tempting offer. However, skipping a payment means not putting any money towards your principal loan amount or interest charges – and the payment you’re missing is still being charged interest, which will all be added to your total mortgage balance.
Let’s say you make your first payment on a $350,000 mortgage on January 1, 2013. With a mortgage rate of 3.28%, your monthly mortgage payment is $1,707. For simplicity’s sake, let’s assume you had this mortgage rate and payment amount for the entire 25-year amortization period of your mortgage.
Unfortunately, your family falls on hard times at the end of 2013, when you lose your job. So, before January 1, 2014 rolls around, you start to think about opting out of your next monthly mortgage payment. The extra $1,707 would help your family that month, but here’s how making the payment vs. skipping the payment would affect your mortgage:
If you skipped your January 2014 mortgage payment, you’d miss the chance to pay down $780 of principal + $927 of interest, and to lower the overall remaining balance of your mortgage. Instead, that interest ($927) would be added to the principal as it was on December 31st ($341,561), so your balance would actually go up (to $342,488) by not making that payment.
How does skipping a payment affect a mortgage in the long-term?
Skipping even just one payment throughout the life of your mortgage results in interest capitalization; this is when your interest is added to the balance of your loan (as shown above), which is continually charged more and more interest, until the day you make your final payment.
To show you how skipping even one payment changes things, let’s return to our example. Assuming the 3.28% mortgage rate and $1,707 monthly payment amount stayed the same for all 25 years, this is how your interest charges and principal would change, if you skipped that one monthly payment in January 2014:
If you subtract the difference between the total mortgage amount paid in both scenarios, the cost of skipping that one monthly payment looks like this:
$514,151 – $512,115 = $2,036
In the end, skipping a $1,707 payment would cost you $2,036.
Can skipped payments eventually be repaid?
The short answer is yes – you can repay a skipped payment at anytime without penalty. However, to avoid it drastically affecting how much interest you’ll pay over the life of your mortgage, you should also pay the additional interest accrued from that missed payment.
What are the eligibility requirements to skip a payment?
If the option to skip a payment is written into your mortgage’s terms and conditions, you’ll just have to meet a couple of criteria. First, your mortgage can’t be in arrears (meaning you can’t have missed 1 or more payments in a row) and, second, the current balance on your mortgage + the payment amount you want to skip can’t exceed the original amount of your mortgage.
Note: It’s also rare for skipped payment privileges to be offered to homeowners with high-ratio mortgages, or those with 10-year mortgage terms.
So, is it a good idea?
This is an entirely personal decision, but one that should be made with a couple of factors in mind. Skipping a payment can certainly offer you some immediate cash-flow relief during an unexpected financial crisis, but it’s important to remember that the relief is (a) temporary and (b) more costly to you in the long run, if you don’t pay back that skipped payment plus interest later on. As well, if you’ve been making extra payments towards your mortgage prior to thinking about skipping one, opting to do so could reverse all of your extra work!
If you find yourself on a tighter budget than you were when you entered your current mortgage term, another alternative to consider is refinancing your mortgage. Going that route, you can either access some equity or get a lower mortgage rate/monthly mortgage payment. To discuss your options, contact a mortgage broker near you.