July 13, 2017
The Effect of Skipping a Mortgage Payment
When you apply for a mortgage, getting the best mortgage rate is just one thing you need to think about. It’s also important to get a mortgage that has features that meet your needs, such as the option to pay down your mortgage early (known as the prepayment privilege).
One feature that many mortgage lenders offer allows you to skip a mortgage payment from time to time. All you need to do is call your mortgage lender a few days in advance and say you want to skip the payment. Many lenders let you choose to skip a payment up to once a year with their approval (late payments or other problems with the conditions of your mortgage would be grounds for them to deny your request).
There are lots of reasons you might want to skip a mortgage payment. An unexpected expense or job loss are two that come to mind. Whatever the reason, skipping a mortgage payment helps with short-term cash flow when you’re in a pinch.
But what are the consequences of skipping a payment?
Beware the Fine Print
Surely, mortgage lenders don’t offer this feature out of the goodness of their hearts. In fact, there’s a financial benefit to allowing customers to skip a payment every once in a while. And while you might not realize it, skipping a mortgage payment is actually very expensive.
To uncover the true cost of skipping a mortgage payment, let’s take a closer look at what happens when you use this feature.
How Skipping a Mortgage Payment Works
Your mortgage payment is made up of two parts: The principal (the amount that goes toward paying back the money you owed), and the interest (the amount that pays for you to borrow the money). Every time you make a mortgage payment, some of it pays down the total you owe and the rest pays for the borrowing cost.
But when you skip a payment, you’re still on the hook for the borrowing cost for that month. And that interest amount gets added to your balance owing. You’re effectively borrowing money to pay for the interest charge—and then paying interest on it!
Let’s look at an example using a mortgage payment calculator.
Imagine you have a mortgage of $500,000 amortized over 25 years with a five-year fixed mortgage rate of 2.24%. Your monthly payment is $2,176. Since the interest portion of the payment gets smaller over the course of your mortgage, let’s make this easier by assuming you’re skipping the very first payment on the mortgage. That makes the interest portion of the payment $933.
As mentioned above, the interest amount gets added back to your outstanding balance when you skip the mortgage payment. Plus, the amount you would have paid doesn’t get applied to the balance. In this example, your total amount owing would go up to $500,933.
|+ Interest owed||+ $933|
|– Payment made||– $0|
|= New balance||$500,933|
Since the interest amount is calculated on the total amount owing, the interest portion of your next monthly payment would increase because you’re now borrowing more money. The interest portion of the next monthly payment would be $935—$2 more than the interest portion would have been on the first payment.
So skipping a mortgage payment costs $2. Worth it, right?
Interest Adds Up
If that was it, skipping a payment would be a great deal. But there’s more to the story.
Because your monthly payment of $2,176 remains the same over the course of your mortgage term, a greater proportion of the next payment goes toward paying interest, at the expense of paying down the principal. For the second payment, you would pay down just $1,241 of your principal, leaving you with a total amount owing of $499,692.
|+ Interest owed||+ $935|
|– Payment made||– $2,176|
|= New balance||$499,692|
After two months, and making a $2,176 payment, you’ve only managed to pay down $308 of your $500,000 mortgage.
Lastly, because you’re paying down the extra amount “borrowed” over 25 years, you’ll actually end up adding five months to the time it takes to pay off your mortgage, and paying $1,637 in extra interest over the life of your mortgage, just for skipping a single payment. That’s assuming your mortgage rate stays the same for the entire 25 years. If your rate were to go up at some point, that number could end up being a lot larger.
If you absolutely must use your skip a mortgage payment, your best chance to counteract this effect is by using your prepayment privilege to make up the payment when you have the money. Making an extra payment toward your mortgage has the opposite effect to skipping a payment. The entire amount of your extra payment goes directly against the principal (you’ve already covered the interest amount in your regular monthly payment). A lower balance owing reduces the interest portion of your monthly payment, and you end up saving money on interest and paying your mortgage down faster.
Related Read: 5 Must-Know Tips to Pay Your Mortgage Off Faster
It’s Best to Stick to Your Payment Schedule
Even if you think you’ll be able to make up for the skipped payment eventually, we don’t recommend the practice. Not only is it costly in the long run, but it can be easy to get in the habit of skipping a mortgage payment as a way to goose your cash flow rather than fixing the problems that led you to be low on funds in the first place.
If you’re having trouble making your mortgage payments, talk to a mortgage broker about your options. They can help you with options to lower your payments through refinancing.