Mortgage Holiday - Who Pays?

gyrex on 21/03/2020 - 00:52
Last edited 21/03/2020 - 01:29

The major banks have announced that they will be offering 'Mortgage Holidays' for up to 6 months (interest still accrues) for customers under financial stress from the impending recession. I was wondering who pays for this? We all know that something doesn't come from nothing. Will shareholders be the ultimate losers from this scheme by a significant reduction in dividends? If this is the case, what happens if those shareholders are relying on those dividends to pay their mortgage thereby completing the loop?

Edit: My question isn't relating to how a Mortgage Holiday works on a functional level but how this deferred payment effects the flow of money within the banking system and, ultimately, its owners (shareholders) and what the potential implications are for them.

Financial Home Loan Loan

Comments

  • Hybroid on 21/03/2020 - 01:03
    +13

    You. Both directly and via affected credit score.

    See monetary example here:-

    Let’ say you have a $400,000 mortgage with an interest rate of 3.5% p.a. where you’re making a principal and interest monthly repayment of $1,796.

    After the first 12 months, your mortgage balance is now $392,323.49.

    Now if you were to take a three month repayment holiday, the interest rate during that period gets added (capitalised) to your home loan principal.

    At the end of the:

    First month: Accrued interest of $1,144.28 is added to your home loan balance.
    Second month: $1,147.61 is added.
    Third month: $1,150.96 is added

    By the end of the three month period, your new mortgage balance will be $395,766.

    You owe an extra $3,443 and because your loan balance is now higher but your loan term remains the same (29 years), your repayments will increase from $1,796 to $1,812.

    You would have paid $646,624 in total if you had stuck to your original repayments. Instead, you’ll now pay $652,190.

    That’s an additional $5,566 over the life of the loan.

    https://www.homeloanexperts.com.au/managing-your-home-loan/r…

    • Mechz on 21/03/2020 - 01:09

      Have they said they won't be extending the life by the 6 months also? Because the longer they have you the better off they are.

      • elgrande on 21/03/2020 - 08:18
        +2

        No. You need to make it up during original time.

    • miwahni on 21/03/2020 - 01:26

      I was wondering about the credit score actually - how will the repayment pause be reported? If it's an agreed pause, can the banks legitimately report it as a missed repayment? I don't think that is right. I think that if the repayment pause has been negotiated with the bank beforehand, they shouldn't be able to report it as a missed repayment.

      • KLoNe on 21/03/2020 - 16:14

        No, it doesn't affect credit score. Missing repayments while NOT notifying the bank will destroy your credit though.

        • miwahni on 22/03/2020 - 01:35

          Wondering how it will look on the new CCR reports though - at present it shows 0 if repayment made by due date (with about 14 days' grace) and 1 if payment was later than that; 2 if two months late etc…. one would hope that, as the pause is negotiated with the bank, the history will still show as 0 for the paused months.
          Well aware of the ramifications of missing payments with no agreement in place, I see a LOT of that on people's reports.

          • El-Rhi on 22/03/2020 - 07:04

            @miwahni: It will likely fall in the category of financial hardship, so RHI will be blank (not 0)

            • miwahni on 23/03/2020 - 23:32

              @El-Rhi: Ah okay, thanks for that. Haven't seen one of those yet.

    • gyrex on 21/03/2020 - 01:26
      +1

      Apologies, It's quite possible my question was somewhat ambiguous.

      I understand fully the implications of deferred interest payments which arise out of a 'Mortgage Holiday'; I'm more interested in where the money originates to facilitate that deferred payment. ie. are shareholders not receiving their full dividend for that 6 month period? I'm interested in how the flow of money works in this scenario. Additional questions relating to this are in my original question.

      • salmon123 on 21/03/2020 - 01:34
        +1

        I'm more interested in where the money originates to facilitate that deferred payment

        There's no simple answer. Some of it will be from deposit holders (APRA might change capital adequacy requirements for banks to improve liquidity). Some will be from RBA liquidity injection. Some will be from borrowing in inter-bank markets. Some of it might be from dividend cuts. Each bank will have a different approach.

        • gyrex on 21/03/2020 - 01:47

          Thanks for your answer. Let me see if I get this right. Let's assume the worst and we enter into a depressionary conditions with unemployment rising to, or above, 20%. We have record levels of mortgage delinquency because of mortgage stress suffered by mortgagees because they've lost their job, business collapsed etc. The banks offer these people 6 month mortgage holidays. This will cost the banks potentially hundreds(?) of billions of dollars over this 6 month period which they use to pay their staff, bills etc. and then finally pay their shareholders. You're saying that this hundreds of billions of dollars might come from the RBA? Do they have this kind of liquidity? What happens if these shareholders are relying on these dividends to pay their own mortgages? It's a vicious circle of hot potato!

          • salmon123 on 21/03/2020 - 10:39
            +1

            @gyrex:

            You're saying that this hundreds of billions of dollars might come from the RBA?

            I'm saying some will come from borrowing from the RBA. I mentioned 3 other sources of funding for a bank.

            Do they have this kind of liquidity?

            It's a trillion dollar question. In the short-term, they certainly do. Who knows about the long term?

            What happens if these shareholders are relying on these dividends to pay their own mortgages?

            That's the risk you take as a shareholder. There's never a guarantee that dividends will be paid.

            It's a vicious circle of hot potato!

            Contagion in financial markets is just as real as this pandemic.

      • HighAndDry on 21/03/2020 - 10:49
        +1

        Dividends are discretionary in the first place.

        You're asking a question that you don't have the fundamentals to understand the answers to.

    • gyrex on 21/03/2020 - 01:29

      Duplicate post.

    • Eeples on 21/03/2020 - 13:15

      For those who take 6 months to find a new job that probably isn’t bad value compared to defaulting.

  • [Deactivated] on 21/03/2020 - 01:37
    -1

    Bank pays but they have been bribed by the government. Millenials pay in the future. The future is always the easy out.

    • garetz on 21/03/2020 - 01:43
      +1

      That is because the future doesnt exist today.

      • Donaldhump on 21/03/2020 - 03:16

        One could argue the Future exists, it just hasn’t occurred.

        • Nugs on 21/03/2020 - 07:30

          What is yet to happen has all happened before.

  • Cluster on 21/03/2020 - 01:59
    +8

    This is a simple business decision. Banks are doing this to maximize profit, not to be nice.

    Consider what would happen if hundreds of thousands of Australians defaulted on their mortgages during an extended COVID shut down. The banks would be left with thousands of homes to sell in a depressed market, and with 80%+ LVR being common the banks may lose money overall. That's before considering the selling costs, lawyers, accountants, etc. What's worse, the depressed real estate market full of repossessed properties pushes everyone's loan closer to being 100% LVR and requiring a top up.

    Better to keep people in their homes and forego a bit of profit now to make a lot more in the future.

    • tomleonhart on 21/03/2020 - 12:00
      +1

      so instead of a lose - lose situation. By offering this, the banks make it a win - win ?

      See i'm a glass half full kind of guy :P

  • Donaldhump on 21/03/2020 - 03:14
    +3

    You do, infact you end up paying more

  • crashloaded on 21/03/2020 - 09:40
    +1

    Mortgage relief or financial hardships is a con.

  • HighAndDry on 21/03/2020 - 10:51
    +1

    No one pays. Your question is misconstrued. It's like if Bob borrowed $50 from you and said he'd pay you today, and then doesn't pay. He just doesn't pay, you're not paying for his lack of payment.

    You lose out on the repayment (for now), same as banks lose out on the repayment (for now).

    • gyrex on 21/03/2020 - 11:09

      Yep, makes sense. I guess the shareholders are the losers here but given these turbulent times, there's going to be plenty of losers in the coming months. I was just intrigued in how the flow of money is affected by the banks not receiving payments and therefore income via interest repayments on the loans.

      • HighAndDry on 21/03/2020 - 11:12
        +1

        Banks write off bad loans all the time. They have more than enough capital reserves to last 6 months, though you're right, if it lasts longer the banks will see a bigger hit to their incoming cashflow.

        Shareholders technically lose, but… share prices aren't directly correlated to a company's actual cash at hand or really any kind of objectively quantifiable valuation.

        • serpserpserp on 21/03/2020 - 11:21
          +1

          Banks write off bad loans all the time.

          The percentage is very small.

          share prices aren't directly correlated to a company's actual cash at hand or really any kind of objectively quantifiable valuation.

          Not true. Cash is a part of the working capital that is evaluated, this evaluation absolutely has an impact on its cash flow analysis and then the overall credit rating valuation for the bank. You can assume that if a bank has zero in ST investments/cash that it is actually in dire trouble given it needs to have a certain amount of liquidity from a regulators standpoint.

          • salmon123 on 21/03/2020 - 11:36

            @serpserpserp:

            The percentage is very small.

            About to get much bigger. Million dollar+ mortgages were never going to end well.

            • gyrex on 21/03/2020 - 11:53

              @salmon123:

              About to get much bigger. Million dollar+ mortgages were never going to end well.

              That completely depends on the mortgagees capacity to pay. The size of the loan isn't the issue, a better metric would be: what proportion of the loans are high LVR loans - these are the potential catalysts for economic catastrophe. The banks offering these mortgage holidays will help ease pressure on mortgagees and the property market in general but my concern is that if this recession/depression is protracted and extends past 6 months, will the banks offer a further bank holiday extension? They can't stem the flow of money forever…

              • salmon123 on 21/03/2020 - 12:12

                @gyrex:

                That completely depends on the mortgagees capacity to pay

                Of course.

                will the banks offer a further bank holiday extension?

                They might, but at the end of the day, we'll see more loan written off.

      • Baysew on 21/03/2020 - 11:33
        +3

        I guess the shareholders are the losers

        You are seeing this all wrong.

        When a bank makes a loan, it is held as an asset. By deferring payments for six months the banks are increasing their assets.

        Shareholders are not "losing" because of this. Banks need to lend to generate profits.

        • gyrex on 21/03/2020 - 12:00
          -1

          When a bank makes a loan, it is held as an asset. By deferring payments for six months the banks are increasing their assets.

          They might be increasing their assets on their balance sheet but these assets have rapidly transitioned from relatively low risk to high risk.

          Banks need to lend to generate profits.

          Assets ≠ profits unless they're realised for a capital gain. The banks are becoming less profitable due to the reduction in revenue from interest payments they would have normally received without the mortgage holiday schemes in place.

  • serpserpserp on 21/03/2020 - 11:17
    +2

    Will shareholders be the ultimate losers from this scheme by a significant reduction in dividends?

    lol this scheme has nothing to do with the reduction in dividends. But make no mistake, the next update by your favourite local bank will most likely announce to the market that they will be suspending dividends.

    • gyrex on 21/03/2020 - 12:05

      I don't understand your assertion here. The banks derive a large proportion of their revenue from mortgages; specifically the interest component of those mortgage repayments. If the bank isn't receiving revenue from those interest payments, their revenue is reduced and dividends to shareholders are effected as a result. This being the case, how can a future reduction of dividends not be tied to mortgage holiday schemes?

      • serpserpserp on 21/03/2020 - 14:24
        +1

        Because even if they weren't giving the mortgage holidays I can tell you that they will be cutting the dividend that is to be announced in the future.

        I think you'll find that the eligible mortgages that will be allowed to undertake this "holiday" won't be as widespread as you think. It isn't like they are going to allow over Owner Occupier to turn this on tomorrow.

      • trashcan on 21/03/2020 - 20:01

        In isolation, a mortgage holiday will not reduce banks profitability. for example -

        Let’ say you have a $400,000 mortgage with an interest rate of 3.5% p.a. where you’re making a principal and interest monthly repayment of $1,796.

        After the first 12 months, your mortgage balance is now $392,323.49.

        Now if you were to take a three month repayment holiday, the interest rate during that period gets added (capitalised) to your home loan principal.

        At the end of the:

        First month: Interest of $1,144.28 is added to your home loan balance.
        Second month: $1,147.61 is added.
        Third month: $1,150.96 is added

        A total of $3,442.85 is added to the loan which is reflected as income in the bank's profit and loss statement. Its interest earned but not received. Bank's do not use cash basis for reporting profit and loss.

        In fact, if risk and cash flow was not a factor in the bank's decision making process, they would prefer a repayment holiday even under ordinary circumstances as that would increase their loan book without any effort on their part….

  • brad1-8tsi on 21/03/2020 - 12:03

    Initially it will affect the banks bottom line and therefore the shareholder but I'd rather give a a 6 month reprieve and eventual payment rather than have a bad loan against the business.

    • gyrex on 21/03/2020 - 12:08

      Yep, the logic makes sense. It's akin to retail/commercial landlords who are offering a reduction in rents during this period to ensure that their tenants stay afloat and keep trading. The worst possible outcome for everyone and the wider economy is if a business/tenant goes under and the landlord has an empty space which they can't lease for who knows how long - the business/tenant loses and the landlord loses.

      • [Deactivated] on 21/03/2020 - 14:45

        Except reduced rents is lost money forever whereas banks are just going to get the same or more money later.

  • activ8newbs on 21/03/2020 - 12:42
    +1

    Sorry haven't had a chance to read previous replies so forgive my ignorance if it's been covered but basically this comes from nothing.

    Source: I used to work in bad debts.

    Yes you pay interest and have to repay after 6 months etc

    But banks aren't Losing money by doing this. Yes they're increasing their risk, but they have provisions in place for this.

    • gyrex on 21/03/2020 - 13:04

      But banks aren't Losing money by doing this.

      Incorrect. The banks are losing revenue in the 6 months these mortgage holidays are in place due to interest payments being deferred and this will be reflected in reduced profits and dividends to shareholders during this period.

      • MrHyde on 21/03/2020 - 14:23
        +3

        Yes, and they will make more money after the 6 month period. More than what they would normally have made without this holiday period.

        So, profits would be higher in the future which would lead to greater dividends.

        The banks are looking at the long game; not the short 6 month period which everyone agrees is going to be bad for everyone.

  • JIMB0 on 21/03/2020 - 12:42

    What happens if the LVR ratio gets too high? Will they foreclose on the mortgage or add mortgage insurance to the loan?

    • activ8newbs on 21/03/2020 - 14:31
      +1

      No sir. Not unless you refinance

  • Gelato on 21/03/2020 - 16:27
    +2

    From afr:

    “APRA jumps in

    Concurrently, APRA announced that banks can temporarily drop below their “unquestionably strong” capital ratios, and lever up their balance-sheets, to enhance their ability to offer the community cheap loans. APRA will also likely allow the banks to avoid raising expensive hybrid and subordinated bond funding for a period while capital markets are dislocated and funding costs are at record highs.

    Finally, on Friday morning the banks announced, with the blessing of APRA, that they will waive for six months all loan repayments of small businesses impacted by the shock, which Frydenberg describes as a “game-changer”.”

  • chumlee on 21/03/2020 - 19:57

    RBA is giving banks billions $$$$ with ultra cheap rates. This will offset higher funding and help profitability

    In saying that, shareholders will take a hit as profits will be down and therefore dividends will be cut

  • trashcan on 21/03/2020 - 20:03

    In isolation, a mortgage holiday will not reduce banks profitability. for example -

    Let’ say you have a $400,000 mortgage with an interest rate of 3.5% p.a. where you’re making a principal and interest monthly repayment of $1,796.

    After the first 12 months, your mortgage balance is now $392,323.49.

    Now if you were to take a three month repayment holiday, the interest rate during that period gets added (capitalised) to your home loan principal.

    At the end of the:

    First month: Interest of $1,144.28 is added to your home loan balance.
    Second month: $1,147.61 is added.
    Third month: $1,150.96 is added

    A total of $3,442.85 is added to the loan which is reflected as income in the bank's profit and loss statement. Its interest earned but not received. Bank's do not use cash basis for reporting profit and loss.

    In fact, if risk and cash flow was not a factor in the bank's decision making process, they would prefer a repayment holiday even under ordinary circumstances as that would increase their loan book without any effort on their part….

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