What happens when your mortgage payments go into arrears?
Before we talk about what happens when your mortgage payments go into arrears, it helps to understand what going into arrears actually means.
The Canadian Bankers Association (CBA) defines going into arrears as missing three or more mortgage payments. However, this is just a rule of thumb. It depends on the mortgage contract that you signed with your mortgage lender. It also usually depends on your mortgage payment frequency. For example, missing three monthly mortgage payments is typically a lot worse than missing three weekly mortgage payments.
When you sign the mortgage commitment package, it’s important to understand that it’s a legal contract. When you fail to pay your mortgage, it’s considered a breach of contract in most cases. When this happens, there are two main options for mortgage lenders:
- The mortgage lender can foreclose on the property. This is just a fancy way of saying that the lender can sue the homeowner for possession of the property and the mortgage payments it’s owed. This is a time-consuming process whereby the courts get involved. If the lender ends up selling your property, you’re left with nothing; although, there is still a window of opportunity to stop the foreclosure process if you’re able to come up with the money you owe.
- A second option is power of sale. This is when your mortgage lender sells your home without taking possession of it. This is most often the option chosen by lenders since it tends to be a lot less time-consuming and less costly than foreclosure and doesn’t need to involve the courts. Under this option, you may still get some money if there’s money left after paying your lender and any other debt you owe.
How does missing mortgage payments affect your credit score?
When you miss mortgage payments, it can do a lot of damage to your credit score. Most mortgage lenders report mortgage payments to the major credit bureaus in Canada, Equifax and TransUnion.
Even if you miss just one mortgage payment, it will appear on your credit report. Mortgages as usually coded as “M” with a corresponding number. “1” means that your mortgage is paid up to date, “2” means your mortgage payment is 31 to 59 days late, “3” means your mortgage payment is 60 to 89 days late, all the way up to “9,” which means that your mortgage debt has been written off, sent to a collection agency or you’ve filed for bankruptcy.
Ideally you want your mortgage to show as “M1” at all times on your credit report. The higher the number gets (M2, M3, M4, etc.), the harder it will be for you to obtaining mortgage financing in the future at a reasonable rate.
Your first step…
If you’re in danger of falling behind on your mortgage payments, the first step is to figure out what the issue is.
Most of us don’t fall behind on our mortgage payments on purpose. Usually, something happens in our life that causes us to fall behind, like COVID-19 for example.
If you’re falling behind on your mortgage payments because you have too much debt, perhaps you could look at consolidating your debt with your mortgage to save on interest and help with cash flow.
Is it because you lost your job? Perhaps you can look into mortgage deferral options, like those currently being offered by Canada’s biggest banks, until you’re able to land on your feet and get a new job.
The bottom line is, once you figure out what the issue is, you can start taking steps to address it and remedy the situation.
Then, consider your options
Mortgage deferrals
When you choose to defer your mortgage payments, this means that you don’t need to make regular payments on your mortgage (including principal, interest and property taxes) for up to six months.
Mortgage help being offered to Canadians during COVID-19
The Coronavirus has had massive effects on mortgage rates in Canada. To help Canadian homeowners stay afloat during the unprecedented COVID-19 pandemic, mortgage lenders are going to extraordinary measures.
The big banks, as well as other mortgage lenders, are offering mortgage payment deferrals for up to six months.
During the deferral period, interest will continue to accrue, but it will provide you with the immediate cash flow relief you need. If you’re approved for mortgage payment deferral, you won’t need to make any mortgage payments for up to six months.
Mortgage payment deferral has proven popular with Canadians. Almost half a million Canadian homeowners with the big banks applied to defer their mortgage payments.
If your employment situation has been impacted by COVID-19 and it’s going to be tough for you to pay your mortgage for the foreseeable future, I strongly urge you to consider applying for mortgage deferral sooner rather than later.
How does mortgage deferral work?
As mentioned, interest will still accrue over the deferral period; however, you won’t need to make any mortgage payments during this time.
At the end of the deferral period, the accrued interest is added to your mortgage account balance. This will result in your mortgage payments being slightly higher when the deferral period is over. Deferring your mortgage payments will result in you paying more interest over the life of your mortgage, but it also helps you with your short-term cash flow needs until you get back on your financial feet.
To help better illustrate what a mortgage deferral looks like, it helps to go through an example together. Let’s say you have a 5-year fixed rate mortgage at 3 percent with mortgage balance of $200,000. Your monthly mortgage payment is $1,379 and the remaining amortization period is 15 years.
When you defer your mortgage payments for six months in this example, it provides you with $8,274 of cash flow savings ($1,379 times 6 months). However, it also results in $2,981 in additional interest added to your mortgage balance at the end of the deferral period. (Whereas if you don’t defer and bite down a bit, you’d be saving that amount.) This means your new mortgage balance after six months will be $202,981 ($200,000 plus $2,981 in additional interest) with a new monthly payment of $1,438 (an increase of $59 over your previous monthly payment of $1,379).
Your monthly payment increases to account for the fact that your remaining amortization decreases to 14 years, 6 months by the end of the deferral period, even though you didn’t make any mortgage payments during that time.
Should you defer your mortgage payments?
Like many things in personal finance, it depends. I would say if you don’t need to defer your mortgage payments, don’t do it. It may provide you with six months of cash flow relief, but that comes at a steep cost (mainly, the extra interest added to your mortgage balance at the end of the deferral period).
If you have a sizable emergency fund and/or you qualify for the Canada Emergency Response Benefit (CERB), you may be fine. However, if you’re not so fortunate and you don’t anticipate returning to work anytime soon, that’s when deferring your mortgage payments may make sense.
Mortgage lenders are considering mortgage deferral applications on a case-by-case basis. Lenders are allowing mortgage payment deferrals on primary residences as well as rental properties.
And in case you’re wondering, no, deferring your mortgage payments should not negatively impact your credit score. It’s not supposed to be reported to the credit bureaus, so it shouldn’t affect your ability to get a mortgage in the future.
Mortgage insurance
If you have mortgage insurance, you may be in luck.
Mortgage insurance protects you in case you default on your payments. It provides you with help paying your mortgage and property taxes when you run into financial difficulties.
If your employment situation has been negatively impacted by COVID-19 and you have mortgage insurance, I strongly encourage you to contact your mortgage insurance provider to see if you’re entitled to any payouts.
If you don’t have mortgage insurance, this can serve as a wakeup call. You might consider signing up for it in the future to protect yourself in a situation like this.
Other mortgage payment relief solutions being offer
Mortgage payment deferral is just one option being offered by lenders. Other options being offered include temporarily lowering your mortgage payments, extending your mortgage term or amortization period, adding missed mortgage payments to your mortgage and lowering your mortgage rate. Some mortgage lenders let you skip a mortgage payment if you’ve made extra mortgage payments throughout the year.
If you’re finding yourself under a lot of financial stress and you’ve explored all the mortgage payment relief options being offered without much success, then you might consider selling your home and downsizing instead. By selling your home and buying a less expensive home, you can free up your cash flow, so you’re not always so strapped for cash.
Again, this isn’t a decision to be taken lightly. Make sure you speak to a few mortgage lenders and brokers. Only after speaking to professionals and understanding your options, should consider this option as a last resort.
The final word
It’s hard to predict how the Coronavirus situation will play out. It seems to be changing day by day, hour by hour. You may be okay in terms of your job situation right now, but that could change tomorrow.
If you’re a homeowner, it’s a smart money move to familiarize yourself with your options in case you run into trouble making your mortgage payments. If your finances are fine now, I’d strongly encourage you to build a sizable emergency fund if you don’t already have one. Saving three to six months’ living expenses can go a long way in helping you the next time you run into financial trouble.
Don’t wait until the eleventh hour. If you anticipate running into difficulty paying your mortgage, talk to your mortgage lender right away. Your lender is more likely to be willing to work with you if you approach them rather than the other way around.
