As part of Canada’s economic response plan to COVID-19, the Federal Government has worked with major financial institutions to arrange mortgage deferral programs for affected Canadians. While payment deferrals can help you through a temporary financial challenge, it’s wise to understand how a deferral changes your loan now, and in the future.
Loan or mortgage deferral is a temporary measure that can help you through financial hardship. While ‘skipping’ debt payments may provide you some relief, it’s an option you should consider carefully as it will affect the cost of your debt over time and could impact your credit score.
A payment deferral is an agreement with your lender to delay loan payments for a set period of time. Your payments are paused, and when the deferral period ends, your payments resume.
To understand how deferral works, you’ll first want to know how loan payments work. As you make payments, a portion of your payment goes toward the balance of the loan (principle), and the remainder of the payment goes toward interest. At the start of your loan term, more of your payment is likely going to interest than to principle. You can confirm how much of your payment goes to principle vs. interest through a recent loan or mortgage statement (Fairstone customers can confirm via online account management).
Generally, loans are charged daily simple interest. This means interest is calculated every day based on the balance of your loan. After each payment, your balance goes down, and interest is calculated on your new lower balance. When you defer a payment, interest is still calculated every day, and because you’re deferring payments, your balance does not change. The interest is then added to your balance owing, since it wasn’t paid off, and your balance grows.
If you are deferring your mortgage payments during the coronavirus pandemic, your lender may offer to delay these additional interest charges until your loan term is up. Then, when you renew your mortgage the additional interest from your deferral period will be added to the total amount borrowed.
Typically, deferral agreements and missed payments will be reported to Canadian credit agencies (Equifax and TransUnion), and can impact your credit score. Deferrals during the coronavirus pandemic may not be reported to the credit agencies, however you should confirm this process with your lender.
While a loan or mortgage deferral can provide you with short-term financial relief, it shouldn’t be looked at as a first option.
If you are considering deferring a loan or mortgage, it’s important to remember the following:
- Deferral is not loan forgiveness, and the debt doesn’t go away – the amount you owe will still need to be paid when the deferral is up
- Once your deferral term is over, your loan payments may be higher, reflecting the additional interest charges
- Payment deferral may be reported to credit agencies, and could affect your credit score
Payment deferrals aren’t the only solution to help you manage debt payments during financial hardship. You can also consider:
- Partial payments: Some lenders may allow you to make partial payments. A partial payment is similar to a payment deferral, but instead of skipping your entire payment you make smaller payments. In some instances, you may be able to pay the interest only, which will prevent interest from building during your deferral term.
- Adjustment of terms: An adjustment of terms involves changing the amount of time you have to pay your loan back. Generally, you and your lender agree to lengthen your loan term, reducing your loan payments by spreading your payments out over a longer period of time. An adjustment of terms will lengthen the amount of time it takes to pay off your loan, and as a result may increase interest charges over the course of the loan, but it’s a more proactive option than late or missed loan payments.
- Loan insurance or creditor insurance: Loan or creditor insurance can cover some or all of your payments during an unexpected job loss, illness or disability that prevents you from working. Check in with your lender to see if you qualify for any loan or creditor insurance you may have opted in to when you took out the loan.
If you are in a position where you can make your loan payments (even only partial payments), you should. This will help you get out of debt sooner in the long run. Before deciding to do a loan or mortgage payment deferral, make sure to ask your lender if they have any other financial relief options to reduce interest charges and help you pay off your loan or mortgage faster.
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