What This “Loan Payment Holiday” Will Cost You | New times
Since March 18, 2020, the National Bank of Rwanda (BNR) has exceptionally authorized banks to restructure the loans of borrowers facing temporary cash flow problems linked to the Covid-19 pandemic. This authorization will remain in effect until May 31, 2021. A loan to a particular borrower can be restructured up to four times during this period.
In this context, a loan restructuring consists of adjusting the terms of the original loan agreement to better suit the borrowers’ ability to repay the loan. It is taken into account by a bank upon receipt of a request from its borrower.
Without the BNR’s overall authorization, banks could only restructure their loans under much stricter conditions given the BNR’s regulatory requirements in terms of provisioning and classification. Fewer borrowers would have been entitled to a restructuring of their loans. As a result, many of them would have ended up defaulting on their loans and facing financial ruin as the banks prey on their property if it was given as collateral. It was therefore a very timely intervention by the BNR.
This has led many banks to invite their customers who are or are facing financial difficulties to apply for their loan restructuring, which is the right thing to do.
However, the language used by banks to advertise or invite borrowers can be misleading as some borrowers will tend to interpret them based on their literal meaning. In their communications to their borrowers, banks often refer to loan restructuring as a “payment holiday”, “grace period” or “moratorium”.
Many borrowers understand these terms to mean that their bank is literally giving them time off from their financial obligations without any negative consequences. But this is a misunderstanding. While it is true that they will indeed be released from all or part of their financial obligations during the period of the “leave”, this leave can also have a financial cost for them.
The monthly loan repayment obligations consist of two components: principal and interest. When you request a payment holiday / moratorium, it can be either a suspension of your principal payments, or a suspension of all your monthly obligations, that is to say (capital and interests). Many borrowers opt for the latter.
If you opt for a suspension of your only principal payments, it means that you will continue to pay the interest during the period of the payment holiday. Suppose you have an outstanding loan of RWF 55 million from the bank. Your current monthly repayment is Rwf 1.2 million and it consists of Rwf 1 million in interest and Rwf 200,000 in principal. If you request a 3 month payment holiday on the principal, it means that you will continue to pay the interest of Rwf 1 million. In this case, it is indeed a holiday because there is no additional financial cost for you besides extending the due date of your loan by the period of the leave, that is to say if your loan were to be repaid within 10 months and you request a 3 month leave, it will now be repaid within 13 months.
If, however, you opt to take a payment holiday on your total monthly obligation, which most borrowers do, there is a financial cost to you. The bank capitalizes the interest. This means that the bank adds the interest you were supposed to pay while on vacation to the total amount of principal outstanding you owe the bank. Suppose you have an outstanding loan balance of Rwf 55 million with the bank. Your current monthly repayment is Rwf 1 million in interest and Rwf 200,000 in principal. If you request a 3 month payment holiday on the total monthly commitment, that means you will not pay anything for the 3 months. But there is a financial cost to you. The total interest that you had to pay over the 3 months, i.e.Rwf 3 million, will be added to your outstanding loan balance of Rwf55 million. You will therefore now owe Rwf 58 million to the Bank. And at the end of the vacation, the bank will charge you interest on 58 million Rwf and not on the original 55 million Rwf you owed. Therefore, your monthly loan repayment of 1.2 million Rwf will increase after enjoying your vacation.
In light of the above, it’s important to ask yourself if you really need the payment holiday in the first place.
The incomes of many borrowers continue to be negatively affected by the effects of the Covid-19 pandemic on our economy. So it makes sense to consider asking your bank for a payment holiday if you’ve been directly affected and are struggling to meet your financial obligations.
However, if you find that you still have enough excess funds left, it may not be advisable to proceed with the loan restructuring. Or if you do, it may be a good idea to go for a payment holiday option that just suspends the payment of the principal and you keep paying the interest. Of course, you will need to determine whether your excess funds will be able to meet your current and future cash flow needs in case your income continues to decline.
Loan restructuring aims to restore financial health and stability to those who face genuine cash flow problems and have absolutely no other option. It’s best to avoid loan restructurings and continue to pay off your monthly payments if you can.
Loan restructuring makes little financial sense because of the increased interest burden. Many borrowers will still find that they have to apply for a loan restructuring due to their current cash flow issues. Banks should make an effort to better explain the financial cost of this leave to their borrowers so that they can make informed decisions. Otherwise, borrowers will have a rude awakening at the end of their “vacation”.
For more specific advice, please consult your bank account manager.
The author is a business lawyer and partner at Trust Law Chambers.
The opinions expressed in this article are those of the author.
Follow on Twitter @Richard Balenzi