First Person: The Pitfalls of Payment Holidays

Those of us with mortgages and great payment histories are often invited to "skip-a-payment" or take a payment holiday once or twice a year. Payment holidays are invitations by your lender to forgo a monthly payment and use the savings to pay off other bills, finance a home improvement project, or even taking a vacation.

What makes a payment holiday so enticing is that it's easy and doesn't affect your credit rating. What the bank doesn't tell you is that payment holidays will extend the term of your mortgage and will cost you thousands in additional interest.

Here's what happened to me.

Back in 2006, I took out a $100,000 mortgage to finance a business venture. The rate was 5.5% and the term was set at 15 years. The payments were $885 a month.

In early 2008, I took the first of 5 payment holidays to cover some unexpected business costs. In late 2008, I took another payment holiday and continued taking holidays whenever they were offered, right up to the time I refinanced in late 2010. What I didn't realize until refinancing was the snowballing effect of payment holidays.

Payment holidays, or skip-a-payments, are pushed to the back of your mortgage. Most of us interpret that to mean that if we skip five payments early on in the mortgage, we catch up those five payments after the mortgage has run its course. What we forget is the skipped interest which continues to accrue. As we approach the end of our loan, it's not just those five skipped payments we have to make up, but also several more payments beyond those just to make up the skipped interest..

Getting back to my example, had I continued making regular monthly payments, my mortgage would have been reduced by nearly $15,000 in four years. But because I skipped payments and incurred an additional $5,000 in interest, my mortgage had only been reduced by $5,600 in this four year period. Ouch.

Payment holidays really do seem like a great solution for freeing up cash, especially when we're struggling to meet other bills. Unfortunately, like any deferred payment plan, a payment holiday really isn't much of a holiday since it will cost us more in the long run.

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