What Does Payment Relief During COVID-19 Really Mean? (Part II)
Let's explore how the payment relief options will affect you long after the pandemic is over. Your financial future depends on making sound decisions now so that you know what to expect later. There are four scenarios that you could encounter after agreeing with your lender to modify your payment schedule.
The payments get added to the end of the loan (extending loan). Example: Instead of a 24-month loan, you now have 27 months. The longer the term, the more likely you could end up underwater on the loan, meaning you owe more than the item is worth.
The amount missed gets added to the balance and is capitalized. What does capitalized mean? The short answer is you will owe more money.
Example. If you owed $500 (principal balance) and the interest (20%) is $100. Making a payment of $400 usually pays the $100 interest first, then $300 goes to the principal (YOU NOW OWE $200 principal).
If they capitalize on the interest, $500 of principal becomes $600 (UNPAID interest $100 + principal $500), then you add interest (20%) to the new principal balance. So the same facts apply to capitalized interest: $600 principal, and the interest is $120 (interest is higher due to the higher CAPITALIZED principal balance). You make a payment of $400, and $120 goes to the interest first, then $280 goes to the principal, BUT you now owe $320 (principal balance).
Lump Sum Payment or Loan Modification
You will have to make a lump sum payment or be forced to do a loan modification. Loan modifications will affect your credit score, and essentially you are being forced into a new loan that might not have great terms. If you were asking for the payment relief, I’m assuming you weren’t able to cover the original payments, so why would you be able to come up with four payments in 90 days? It doesn't make sense, but that's how lenders make more money by piling on more debt.
Oftentimes the lender wants all of the missed payments at the end of the grace period plus the amount that gets you back on schedule. If you are unable to pay the lender the lump sum, they could decide that you have breached the terms of your loan and require that you refinance the loan. If you have good credit, you might get a better interest rate than you had, but refinancing/loan modifications cost money, and believe me, YOU are paying those costs in the long run.
If the lender "forgives/waives/cancels" the payments, you will end up fighting with the IRS because THE IRS WILL CONSIDER the loan cancellation/forgiveness INCOME TO YOU AND TAX IT. (It's no longer a loan, it's a cash gift.)
Bottom line: If you need the payment relief, work with your lender, and understand what you are asking for because this is not a free pass.
To read Part I of the article, click here.
Jala Eaton, Esq., is a certified trust and financial advisor. If you are in need of trusted financial advice, please contact her at www.onmyownfinancial.com.