Q. Is now a good time to deal with my debt or wait and try to use the payment relief programs the banks are offering?
This is a question we are being asked every day throughout our 4 Pillars offices. Prior to this crisis, millions of Canadians were already struggling to pay off their debt and looking at debt restructuring options or even bankruptcy. Now the situation has been compounded and many people are not just struggling to pay credit card debt, they are struggling to pay mortgages, utilities and put food on the table. The banks are creating hardship and payment relief programs that are critical in helping consumers during these unprecedented times. However, the measures that should be creating a feeling of relief are leaving many borrowers feeling confused and anxious because of mixed messages with no clear understanding of the long-term costs.
We are concerned about how this will play out for borrowers over the coming months and years. The payment relief programs will allow many people to delay their mortgage and other debt payments for 3-6 months and possibly longer. But debtors are often making decisions without a clear understanding of the long-term financial implications.
Here is the bottom line on paying your mortgage:
If you can pay your mortgage, we advise continuing to do so.
But if you are experiencing financial hardship and you cannot pay your mortgage, call your lender immediately and ask them what payment relief options are available. Pay close attention to when your lender expects you to pay, when the payment relief is over, and on what terms, then get it in writing. This will not only ensure the lender sticks to what was agreed to but allow you to remember too. This is a stressful and emotional time and key points are easily missed or misunderstood.
Remember, your home is at risk so don’t bet your house on your recollection or the lenders call centre operators ability to accurately document what was agreed. Confirm everything in writing, everything.
Let’s look at what happens when you take payment relief.
The quick version – Pay less right now, but over the course of the mortgage or other debt you stand to owe thousands of dollars more because of interest charges.
A very cynical view of the banking system is by offering customers “relief”, the banks stand to increase profits over the long term.
However with the economy in free fall, cash flow is a huge issue and deferring payments now could keep many in their homes and allow them to put food on the table until things turnaround.
Albeit programs from the major banks differ, there are some key points to remember:
The programs are not debt forgiveness. In other words, no debt is being written off, it’s only being deferred.
Payment deferral means that payments are skipped for a set period, during which interest (which would be paid as part of the deferred payment) continues to be added to the outstanding balance.
Interest will be incorporated into the monthly payment when payments resume.
Let’s look at an example:
If you defer your mortgage payments for the next six months, the interest will continue to accrue, so when you resume payments the balance will have increased the amount of 6 months interest and maybe more if the interest is compounding. This means you need to increase your monthly payments to pay it off or extend the amortization of the mortgage and take longer to pay it off. At this points its unclear which options the banks will offer, regardless it will result in additional interest payments.
A very quick calculation shows based on a mortgage of $500K at current interest rates that homeowners who takes a 6-month payment deferral on their mortgage payments could end up paying over $20,000 more in interest and/or increase the time it takes to pay off the mortgage by over 12 months.
The unknowns
How will it report on the credit bureau?
Interest rates have been cut to historical lows due to the current crisis. What if they increase, which is a strong possibility once this is over.
The above example was based on skipping mortgage payments, with interest rates around 3.5%. Imagine the cost of skipping credit card payments with interest rates of 18%.
Is now a good time to look at debt restructuring?
If you still have a source of income, now could be a very good time to take action and deal with your debt vs look at payment deferrals. Here’s why:
Payment deferrals simply shift the problem to a future date. If you know your debt is unmanageable now, it will be more unmanageable after the payment deferral is over. Even if the creditors aren’t reporting missed payments to the credit bureau during the payment deferral, they will once it’s over.
Your debt will increase after the payment deferral, meaning any new debt restructuring plan will likely require a higher payment.
Creditors are more flexible in a time of crisis and most will be willing to accept a lower offer to repay the debt. Once we have recovered from this, the banks will also be looking to recover financially. This may mean they are looking for higher returns on insolvencies and other debt solutions to minimize losses.
In 6 months time the insolvency and debt help system could be overwhelmed with new cases resulting in significant delays to get appointments and finalize any debt solutions. In the meantime, the creditors will have recommenced collection practices and will be aggressively looking to collect on delinquent payments.
The sooner you take action, the sooner the financial stress is relieved, the sooner you become debt free and the sooner you can begin rebuilding your credit.
The bottom line is if you have lost your income, payment deferral may be the best short-term option.
However, if you know the debt is unmanageable, help yourself remove some of the stress by looking at your options now. There are several different options available from budgeting to bankruptcy and everything in between. Start preparing now and be ready to move forward as soon as your income has returned to normal. There is a lot of planning and preparation that can be done to avoid delays in the future.
If you still have income or the ability to offer a one-time payment to your creditors to settle unmanageable debt, now may be the best time to do it.
