Payment Holiday – a blessing or a trap?

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A payment holiday on your debt is when the lender gives you a temporary suspension of your repayments in the condition that you are unable to pay your debt obligations. It sounds too good to be true right? What is the catch? Is a payment holiday a blessing or a trap?

Despite the fact that Payment Holidays can be very useful as a tool for debt relief, it may not be the best approach to use. It is crucial to note that the Payment Holidays do not exempt your debt from accruing interest and other service fees.

However, if there is no any alternative debt relief available to you, Payment Holidays ensure that you do not disturb your Credit Score. If you skip monthly payments without consulting your lender, you will lose points on your Credit Score which can heavily affect your ability to borrow money in the future.

It is just a good practice to have a back up plan that can help you in times of financial distress. Read the following posts for more:

• Invest with purpose – making the first steps.
• The impact of small steps and consistency on money management.

How the Payment Holiday works

To illustrate how the Payment Holiday works, we are going to use a practical example.

Practical Example

Suppose you have a R 20 000 loan with the bank with the following conditions:

• annual Interest rate of 20%,
• term of 5 years,
• repayments are paid monthly,
• loan initiation fees amounts to R 1 207.50.

For the sake of simplicity, we will ignore the service costs and the insurance premiums associated with the loan. Suppose that in the 13th month of your term, you find yourself in a big financial distress and the bank offered you a 3 month Payment Holiday. We want to observe if the Payment holiday is a blessing or a trap.

Loan	Normal Payments	With Payment Holiday	Differences
Monthly Payment	R 561.87	R 561.87	R 0
Number of Payments	60	64 (excluding 3 month payment holiday)	4
Total Interest Payable	R 12 504.64	R 14 665.02	R 2 160.38

From the table above, taking 3 months Payment Holiday resulted in the number of payments increasing from 60 to 64. That is, taking a Payment Holiday will add you 7 months of paying off your loan which translate to extra 4 months of normal monthly repayments.

Moreover, another interesting note is that the Total Interest payable during the lifetime of loan increased by R 2 160.38. This is because when you take a Payment Holiday, your are doing nothing to reduce your Outstanding Loan Balance while at the same time you are required to pay interest, service fees and premiums for the loan insurance. Therefore, both the Balance and Interest will increase for those 3 months.

Graphical approach

This can also be summarised as is figure 1 below:

Note that the Outstanding Balance curve (With Payment Holiday) was falling for the first 12 months before the Payment Holiday and then it rises during the 3 months Payment Holiday. After the payment holiday, the Balance resumed the decline at a slower pace than the Normal Payments Balance curve.

What are the alternatives?

There are several ways that you can use as an alternative for debt relief. This depends on the situation you are facing.

If you are retrenched from your job, check if you have a loan insurance that covers death and retrenchment. In the condition that you have the loan insurance, then you can claim from the insurance instead of applying for a Payment holiday. Depending on the loan insurance you have, the insurance can cover up to 12 months of retrenchment.

Additionally, if your are not retrenched, you can negotiate for a payment arrangement with your lender. This may mean that you can negotiate to reduce your monthly repayments during the crisis then increase your monthly payments when the crisis is over.

Conclusion

Payment Holidays will result in increased number of payments as well as the total interest payable during the lifetime of the loan. If you are retrenched, the best option is to claim from your loan insurance. However, the Payment Holiday can be a blessing if you find yourself unable to pay your monthly payments for other reasons besides retrenchment. You will be assured that your credit score remains unaffected until the Payment Holiday is over.