Who doesn’t enjoy a nice, relaxing vacation? When you hear “mortgage vacation,” you probably imagine yourself lying on the beach, sipping on umbrella drinks. Although you have the vacation part right, you forgot the most important part – your mortgage. A mortgage vacation lets you skip paying your mortgage for a few months after you’ve made mortgage prepayments – with a catch.
Mortgage vacations have become a popular feature among mortgage lenders. Here’s how they work: if you run into financial difficulty or you want to use your mortgage payment towards something else, you can go on a mortgage vacation. A mortgage vacation can save you when you’re in a financially bind, but it can also cost you dearly. Through properly financial planning you can avoid going on a mortgage vacation and keep your dreams of being mortgage-free on track.
What is a Mortgage Vacation?
Have you ever received a letter from your lender informing you you’ve been approved for a mortgage vacation? Lenders market mortgage vacations like they’re a privilege, but hidden within the fine print are the consequences of taking a break from paying your mortgage.
To get a better idea of how mortgage vacations work, let’s run through an example. Let’s say your regular mortgage payment is $1,200 per month and you want to skip paying your mortgage for three months while you work overseas in Europe. Unfortunately, there’s no such thing as a free lunch in personal finance. You’ll need to plan ahead of time and prepay the equivalent of three months’ of mortgage payments – that would be $3,600 extra ($1,200 X 3 months).
$3,600 is a lot of money to come up with at once, especially when you’re a homeowner on a tight budget. That’s where your prepayment privileges come into play. By planning ahead you can prepay your mortgage vacation amount – $3,600 – over a longer period of time. For example, if you have a year until your mortgage vacation, you can prepay an extra $300 per month ($3,600 / 12 months) towards your mortgage – that would increase your regular mortgage payment from $1,200 to $1,500 per month ($1,200 + $300).
So What’s the Catch?
It may be tempting to take a mortgage vacation at first glance, but we haven’t discussed an important part yet. When you take a mortgage vacation, although you’re getting a break from paying your mortgage, you’re still accruing interest on your outstanding mortgage balance.
What are the consequences on your mortgage vacation? A little thing called interest capitalization – interest will be added back to your outstanding mortgage principal. Not only could you end up paying thousands in additional interest over the life of your mortgage, you could also extend the amortization period of your mortgage – ouch!
Does it Ever Make Sense To Take a Mortgage Vacation?
Although mortgage vacations will cost you a lot long-term, it’s better than defaulting on your mortgage, losing your home, and ruining your credit rating. For most families their mortgage payment represents their largest household expense. Although mortgage vacations can provide short-term relief from financial hardship, it’s important to remember it’s a loan – you’ll have to get approval from your lender ahead of time. If you’ve lost your job and you’re in financial trouble, your mortgage vacation may not be there when you need it most.
Plan Ahead and Avoid Taking a Mortgage Vacation
Unless you have high-interest credit card debt, it’s a good idea to have an emergency fund. Depending on your financially stability, a good rule of thumb is to set aside between three and six months’ living expenses in your TFSA or a high-interest savings account.
If you’d like to take a break from paying your mortgage, why not save that extra $300 in your high-interest savings account. That way you can use the funds for you planned trip overseas and avoid going on one of the most expensive vacations you’ll ever take.
Have you ever gone on a mortgage vacation? Do you have an emergency fund in place for a financial emergency?
I've Completed My Million Dollar Journey. Let Me Guide You Through Yours!
Sign up below to get a copy of our free eBook: Can I Retire Yet?