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Why A Mortgage Payment Vacation Is A Bad Idea

We have been paying an extra $600 per month on our mortgage since we moved into our new house last summer.  We are taking advantage of increased payment options to reduce our total interest costs and pay down our mortgage faster.  Our goal is to pay off our mortgage in less than 15 years.

Apparently our bank doesn’t think this is such a good thing.  I received a note last month from TD Bank informing me that I’ve won a vacation – a mortgage payment vacation, that is.  I’m going to explain what a mortgage payment vacation is, and why it’s a bad idea:

Mortgage Payment Vacation

The note from TD Bank said that I may apply an approved amount that I already prepaid to a maximum of 4 consecutive monthly or equivalent to monthly regular mortgage payments for a mortgage payment vacation.  Interest continues to accrue during the mortgage payment vacation.

Since we’ve already prepaid the equivalent of 2 or 3 extra mortgage payments, the nice folks at the bank figure we can take a break for a few months while the interest builds back up.

It seems like the banks are trying every marketing tactic they can in order to make more money in this low interest rate environment.  No wonder Canadians are in trouble when it comes to household debt.

The Sales Pitch

I was curious to hear more about taking a mortgage payment vacation so I checked out TD’s website for more information.  They have a whole exercise dedicated to this feature:

If you’re planning for a big or life-changing event like staying home with a new baby, taking a sabbatical from work, taking an extended trip or pursuing your studies while working part-time, a mortgage payment vacation is a good option to consider.

Ken and Cheryl are expecting their first child.  They meet the eligibility requirements and would like to take a mortgage payment vacation during their parental leave. To do so, they’ll need to accumulate a prepaid amount in the time before baby arrives.

Here’s how this works:

Ken and Cheryl’s regular monthly mortgage payment is $902 per month.  Ken and Cheryl would like to take a mortgage payment vacation for 4 months while they’re on parental leave.  Their prepayment goal is $3,608 ($902 x 4 months).

Ken and Cheryl have 9 months to prepay $3,608.  They will need to pay an extra $401 per month, so their monthly mortgage payment over that time will be: $902 + $401 = $1,303 per month.

Now they can apply any prepaid amounts accumulated from lump sum payments or accelerated payments to take a break from their mortgage payments for up to a 4-month period.

This feature is available on new mortgages, or when you renew your existing mortgage.  You must have accumulated the prepaid amount by taking advantage of prepayment privileges.

Mortgage Payment Vacation – A Bad Idea

A mortgage payment vacation results in interest capitalization.  This means interest will be added back onto the outstanding principal on your mortgage.

TD Bank also says that, if necessary, they will adjust the amortization period remaining at renewal so that the mortgage does not exceed the original amortization period remaining.  This may result in an increase to the amount of your regular payments after the renewal.

The bottom line is that taking a break from paying your mortgage is a bad idea.  The banks are trying to turn your good savings habits into bad ones.  They’re making it too easy for people to get sucked into the debt trap forever.

It’s pretty obvious that Ken and Cheryl should just set aside the extra money in a high interest savings account every month until their ready take parental leave.  They can continue to make their monthly mortgage payments, and maybe they can treat themselves to a real vacation when it’s paid off.

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24 Comments

  1. youngandthrifty on February 27, 2012 at 1:52 am

    Wow, that’s scary that the bank would send that to you! I’m with RBC and I don’t think I’ve noticed a mortgage payment vacation flyer.

    Congrats on paying down your mortgage extra by $600 a month! On one income! With a kid! That is amaaaazing 🙂

    You are definitely on your way to your Findependence day. 😉

    • Echo on February 28, 2012 at 12:02 am

      @youngandthrifty – it wasn’t a flyer, it came as a message when I logged on to their website.

      Thanks – I’ll be happy to reach my Findependence Day by the time Jamie did in the book, minus the drama 😉

  2. Money Infant on February 27, 2012 at 2:33 am

    I won’t say I’m surprised, but it is shocking the ways that the banks will try to “trick” you into paying them more in interest. This on top of added fees, begrudging interest on deposits and the fact that many of them are more profitable than ever.

    • Echo on February 28, 2012 at 12:03 am

      @Money Infant – yes, the banks act like they’re doing us a favour.

  3. Marianne on February 27, 2012 at 8:38 am

    Wow! I have never heard of this! It falls in line with all of the other convenience products that benefit the banks though so I am not sure why I am surprised. We sort of are able to take a mortgage vacation if we want on our own accord (Manulife One account) but of course we do not wish to do this! I will say that it was a bit of extra peace of mind when I was unsure of how much the mat. leave benefits were going to be and I was trying to budget. Thankfully we haven’t had to take a ‘vacation’ yet. 🙂

    • Echo on February 28, 2012 at 12:08 am

      @Marianne – the price of convenience is usually pretty steep.

      Good point about the Manulife One account – they are probably counting on customers to take a break every once and a while. Way to stick it out!

  4. Michael James on February 27, 2012 at 8:42 am

    My wife and I used to pay extra on our mortgages as well. We got many offers to skip a mortgage payment, but never took them. As long as you’ve demonstrated that you don’t need to skip a payment, the bank is happy to let you do so.

    • Echo on February 28, 2012 at 12:10 am

      @Michael James – yes, and the credit card companies are even worse; trying to sell me balance protection insurance and identity theft protection even though I pay my card off every month.

  5. Money Beagle on February 27, 2012 at 9:24 am

    I’ve always laughed at these and immediately pitched them. It’s basically taking out another loan but with the period the amount of time you have left on your mortgage. Not worth it in 99% of cases.

    • Echo on February 28, 2012 at 12:16 am

      @Money Beagle – I suppose there could be a situation where it makes sense to do this, but I still think people would be better off putting aside cash in a savings account.

  6. krantcents on February 27, 2012 at 9:55 am

    This is a conflict of vested interests. The bank wants to earn money on their loan and you want to pay less in interest. They are are using this as a maketing campaign. You are not obligated to take it.

  7. SE Book on February 27, 2012 at 12:09 pm

    Yea I am surprised people have even considered this.

  8. Boomer on February 27, 2012 at 12:26 pm

    This strategy is nothing new. Many years ago I had a mortgage with BMO and they offered the same thing every year. We could skip a payment in December and January, presumably to ease the money crunch at Christmas time.

    I regularly get my credit card statement with a zero amount due. They don’t like that I pay my entire balance each month. Interest payments are a large part of profits for financial institutions.

    • Echo on February 28, 2012 at 12:17 am

      @Boomer – you bankers, up to your old tricks again 😉

  9. Astro Gremlin on February 27, 2012 at 9:02 pm

    Echo, thanks for the heads up on this strange development. Paying a little extra on your mortgage gives you a shorter term and lowers the principal in case you refi but it’s not cause for a vacation. Speaking of refinancing, now is the time!

  10. My University Money on February 27, 2012 at 10:36 pm

    Come on now, where is your patriotic spirit Echo? Didn’t you see the headlines the other day that our banks are seeing shrinking profits these days? I mean, if we refuse to do things (that are to our benefit anyway) like paying extra interest on our mortgages, how do we expect these people to put food on their plates with mere billions in profits?

    • Echo on February 28, 2012 at 12:19 am

      @My University Money – yeah, poor guy at Scotiabank only made $10M this year. How will he afford his diamond shoes?

  11. Sudip Adhikari on March 3, 2012 at 10:48 am

    Nice roundup.
    But the idea is bad or good depends on the financial situation of the person it pitched at.
    It is a very attractive lure for those who are into poor financial condition. Not everyone have good credit score. Once they bite the bait, they get trapped more into debt.
    Surprisingly the default rate is still low.

  12. Returns Reaper on March 4, 2012 at 4:05 pm

    I’ll be the first to admit this is a bit predatory and the last thing someone who is bad with debt needs. But for a responsible saver, isn’t this a fantastic financial tool?

    Suppose someone has the option of paying extra on a 5% mortgage with the ability to essentially withdraw the extra payments later (by way of not paying the mortgage in the future).

    Mathematically, doesn’t this work out to be equivalent to putting money into a 5% savings account, where the gains are tax-free? This sounds like one of the best savings accounts out there. You’d be typically hard-pressed to find a savings account that will pay a rate greater than or equal to your mortgage rate. Especially after factoring in taxes if you don’t have room in your TFSA.

    Again, I’ll stress that this would be more likely tempt people to do bad things with their money rather than good things. But if we take human emotions and psychology out of the mix and look at it purely from a mathematical viewpoint, it looks like quite a good deal, provided people properly plan ahead.

  13. Farhaneh Haque on March 12, 2012 at 10:39 am

    Flexible features like payment vacation or payment reduction promote responsible repayment behaviour and can prove helpful if something unexpected arises.

    By paying their mortgage ahead of schedule, customers will have the ability to pay a little less for a while or, if they want to, take a payment vacation for a period of time to accommodate a care leave or a sabbatical.

    We think it’s important to be able to provide mortgages that offer the kind of flexible payment options that allow our customers to worry less about their mortgage so they can focus on their lives. Not to mention that in paying their mortgage ahead of schedule customer can in fact save on the interest payments over term and get out of debt faster!

    • Echo on April 22, 2012 at 8:58 am

      @Farhaneh – Paying your mortgage ahead of schedule is definitely a good thing – no argument there. My problem with the mortgage payment vacation is that it’s being aggressively promoted by TD (meaning there must be a benefit to TD for home owners to do this).

      To me, this is like promoting the fact that you can withdraw from your RRSP if you need the money. Sure, it’s a nice option to have if you find yourself in a real mess financially. But it should be a last resort for people.

      • Farhaneh Haque on April 23, 2012 at 9:42 am

        Over the years our customers have told us that they:
        – want to paydown their mortgage debt faster, and
        – want to have a rainy day fund set aside for life’s emergencies.

        Flexible Mortgage Payment Features like the payment vacation let customers plan ahead to get the most out of their mortgage and meet both their goals of being debt free faster while still having a safety net.
        For example, if someone was planning on staying home with a new baby, they could make lump sum payments or pay a little more each month by increasing their regular payments preceding the leave, so that they can then apply to their take up to four months off.

        This is somewhat different from turning to your RSPs because you can proactively plan for life events and be financially prepared for them. If you don’t need to take the payment vacation or reduction, then in the least, you have paid down your debt, which we agree is a great thing!

  14. Scott on April 19, 2012 at 7:48 am

    Hi Echo,

    Would you be able to do a quick comparison between the benefit of the prepayments, then the cost of the vacation vs. no prepayments and the funds kept in a high interest savings account? Also is there a difference between the rates that would actually yield this as a benefit?

    • Echo on April 22, 2012 at 9:21 am

      @Scott – I don’t have a good amortization calculator that would allow me to run the different scenarios. I see where you’re coming from though. I think it depends on how long you made pre-payments on the mortgage.

      I prefer to keep things simple. When I make pre-payments on my mortgage, it’s for the purpose of paying off my mortgage early. The bank is not your friend. They didn’t come up with this promotion to do you a favour; they did it to extend the life of your mortgage and add to their profits.

      Alternatively, you can look at something like Manulife One (https://boomerandecho.com/is-manulife-one-worth-a-look/) where you combine all of your debt, savings and income into one chequing account.

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