Covid-19 certainly calls for extreme measures. The financial impact on individuals and businesses is extreme. The impact on the economy is extreme. Individuals and businesses are desperately looking for solutions to carry them through the lockdown period as well as the recovery phase thereafter. Most banks and other credit providers have offered payment holidays. Payment holidays are a welcome relief and definitely one solution to consider. It is however important to fully understand what a payment holiday entails, and what the impact thereof is over the longer-term.
What is a payment holiday?
A payment holiday, also referred to as a repayment break / holiday, grants individuals or businesses the opportunity to take a break from paying their installments on a bond or other credit agreement. Depending on the agreement the break is usually granted for a period of one to three months. A payment holiday is a short-term solution offered by financial institutions and credit providers to support individuals or businesses experiencing cash flow strain. Payment holidays are only granted in exceptional circumstances where the individual / business might not have the necessary income to service their commitments due to retrenchment, salary reduction, maternity leave (unpaid) and unforeseen expenses / circumstances.
Covid-19 impact calling for payment holidays
Covid-19 is a typical example of an unforeseen circumstance / expense. The outbreak of the coronavirus and the 21-day lockdown period will have a significant financial impact on most individuals and businesses, as well as economies worldwide. Many businesses had to close down completely or cannot trade as usual while many employees had to take unpaid leave or salary reductions. Most banks and other credit providers have already announced their plans to grant payment holidays or invited clients struggling to make ends meet to get in contact with them to make arrangements. Banks are committing to specifically help small business owners through this period with the intention that small businesses should rather use the money to pay salaries to their employees and pay other commitments to lessen the overall impact.
The idea of a payment holiday might be a welcome relief to many, but what should you know about it?
No installment payable BUT interest is still charged
You won’t have to pay your installments for a period of time and will have additional cash flow in your pocket during that period, BUT interest and fees will still be charged in the majority of cases during the payment holiday period i.e. the interest portion will increase your outstanding balance. It is only under certain strict conditions, for example a student loan, that banks will waive the interest portion too, but then usually readjust the repayment period of the loan to recover the money in the latter stages of the loan repayment period. Therefore make sure you fully understand the terms and conditions set by your bank / credit provider with regards to payment holidays granted as a result of the Covid-19 situation.
Here are two examples to illustrate the impact of a payment holiday:
Example 1: Outstanding loan of R1,000,000 (8,75% flexi-interest) with monthly repayments for 4 months under normal circumstances.
|R 1 000 000||Current|
|Current Interest Portion||Current Capital Portion||Outstanding Balance|
|Month 1||R 8 773||R 7 292||R 1 481||R 998 519|
|Month 2||R 8 760||R 7 281||R 1 479||R 997 039|
|Month 3||R 8 747||R 7 270||R 1 477||R 995 562|
|Month 4||R 8 734||R 7 259||R 1 475||R 994 087|
During a normal monthly payment cycle you will pay an installment of R8,773 in month 1 of which R7,292 relates to interest and the remaining R1,481 will be deducted from the outstanding capital amount. Thus: R1,000,000 (original loan) + R7,292 (interest) – R8,773 (installment) = R998,519 (outstanding balance) / R1,000,000 – R1,481 = R998,519
During a normal monthly payment cycle you will pay an installment of R8,760 in month 2 of which R7,281 relates to interest and the remaining R1,479 will be deducted from the outstanding capital amount. Thus: R1,000,000 + R7,281 – R8,760 = R997,039 / R1,000,000 – R1,479 = R997,039
Under normal payment circumstances both the installment and interest portion will slightly reduce on a monthly basis. At the end of month 3 the original outstanding balance of R1,000,00 would have reduced to R995,562 and from month 4 the monthly installment and interest portion will continue to reduce slightly because of the capital amount / outstanding balance reducing.
Example 2: Outstanding loan of R1,000,000 (8,75% flexi-interest) with a 3-month payment holiday.
|R 1 000 000||Current|
|Current Interest Portion||Current Capital Portion||Outstanding Balance|
|Month 1||R 0||R 7 292||R 0||R 1 007 292|
|Month 2||R 0||R 7 345||R 0||R 1 014 637|
|Month 3||R 0||R 7 398||R 0||R 1 022 035|
|Month 4||R 8 966||R 7 452||R 1 514||R 1 020 521|
As a result of a payment holiday granted you won’t pay an installment during the 3 months. Since you are not paying an installment there will also not be a capital portion being deducted against your outstanding balance during the payment holiday, therefore your outstanding balance will not decrease. However the monthly interest is still being charged and capitalized against your outstanding balance, with the result that your outstanding balance will in fact increase with the interest portion on a monthly basis as there is no installment to cover the interest.
Thus: R1,000,000 + R7,292 = R1,007,292 at the end of month 1.
Thus: R1,007,292 + R7,345 = R1,014,637 at the end of month 2 etc.
At the end of month 3 the original outstanding balance of R1,000,00 would have increased to R1,022,035 because of the capitalisation of the interest portions. With a payment holiday both the installment and interest portion will increase from month 4 after the payment holiday because of the higher outstanding balance at the end of period 3.
A payment holiday will provide you with additional cash flow of R26,280 (R8,773 + R8,760 + R8,747) due to not having to pay installments for a period of 3 months. Your outstanding balance will show an increase of R26,473 (R1,022,035 – R995,562) at the end of month 3 resulting in higher installments and more interest payable over the remaining of the loan period.
What else should you know about payment holidays
- Don’t stop paying any installments on the assumption you will automatically qualify for a payment holiday because of the coronavirus and the assistance banks are offering during this difficult time. This is something you need to contact and agree with your bank / credit provider. Any missed or late payments will impact negatively on your credit rating.
- Standard Bank announced that they will automatically apply the payment holiday to all student loans and small businesses with a turnover not exceeding R20 million that meet the pre-set criteria unless you opt-out. If you do qualify and don’t want the payment holiday, please ensure that you opt-out. Most of the other banks indicated that clients can contact them to discuss the options available and whether they qualify.
- Whether you apply for a payment holiday or not, ensure that you review your monthly statements, especially for the next few months, to immediately identify any irregularities i.e. incorrect calculations, not deducting your installment although you haven’t applied for a payment holiday, additional charges etc. Notify the bank / credit provider immediately if you identify errors. The Covid-19 situation is an abnormality and both systems and people can easily make errors under abnormal circumstances.
- The intention with a payment holiday is definitely not to use the money for unnecessary expenses like paying for a holiday or buying a new TV. The bank or credit provider may ask for proof of what you will be using the money for.
- Payment holidays are typically available for bond and car financing, however other forms of credit (personal / business loans etc.) can qualify too.
- There aren’t fixed rules for payment holidays and the conditions under which payment holidays are granted may differ from institution to institution. Therefore make sure you understand the terms and conditions of your bank / credit provider especially if you have credit arrangements with different banks / credit providers.
- Many institutions grant a payment holiday only once. Once you used it you cannot apply a second and a third time. Make sure you only apply for this option if there are absolutely no other alternatives.
- Your credit history and record will be looked at before a payment holiday will be granted. If you don’t have a good credit score your application for a payment holiday might be declined.
- A payment holiday does negatively impact on your credit rating. Your outstanding balance and installment will be higher following the payment holiday and although the break in payment was agreed upon with your bank / credit provider it could affect your ability to apply for credit in future. It is important to ask and understand what the impact on your credit rating will be.
- Needing a payment holiday, might be an indication of a much bigger underlying concern – you are over-indebted. Have an honest look at your overall level of debt and whether you can afford the installments. The golden rule of thumb is that your debt installments should not exceed 20% of your net monthly salary after deducting tax, retirement and medical aid contributions. If you are over-indebted, get help sooner than later!
- Remember a payment holiday is a short-term solution for 1 to three months. Would you have recovered after the payment holiday to resume repaying your installments? If not, do you have an alternative solution thereafter?
Like with anything else in life there is hardly ever a ‘free holiday’. A payment holiday will definitely assist you with improved cash flow over the shorter term, but do make sure you fully understand the impact thereof over the longer term. Only opt for a payment holiday if there really is no other alternative.
I pray that all individuals and businesses will recover rapidly after the lockdown period and come out stronger than before.