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What that “loan payment holiday” is going to cost you

Since March 18, 2020, the National Bank of Rwanda (BNR) has exceptionally authorized banks to restructure loans of borrowers facing temporary cash flow challenges arising from the Covid-19 pandemic this authorisation will remain in effect until 31st May, 2021. A loan to a particular borrower can be restructured up to four times during this period.

In this context, a loan restructure entails adjusting the terms of the original loan contract to better suit the borrowers’ ability to repay the loan.  It is considered by a bank upon receiving a request from its borrower.

Without BNR blanket authorisation, banks would only be able to restructure loans under much stricter conditions in view of BNR’s regulatory requirements on provisioning and classification. Fewer borrowers would have been entitled to have their loans restructured. Consequently, many of them would have ended up defaulting on their loans and facing financial ruin with the banks going after their property if it was given as collateral. It was therefore a very timely intervention by BNR.

It resulted in many banks inviting their clients who were or are facing financial challenges to apply for their loans to be restructured which is the right thing to do.

However, the language used by the 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, the banks will often refer to the loan restructuring as a “payment holiday”, “grace period”  or “moratorium”.

Several borrowers understand these terms to mean that their bank is literally granting them a holiday from their financial obligations without any negative consequences.  But it is a misunderstanding. While it is true that they will indeed be free of some or all of their financial obligations for the period of the “holiday”, that holiday may also come at a financial cost to them.

The monthly repayment obligations on a loan constitute of two components: principal and interest. When you ask for a payment holiday/moratorium, it can either be a suspension of your principal payments or a suspension of your total monthly obligations ie (principal and interest). Many borrowers opt for the latter.

If you opt for a suspension of only your principal payments that means you will continue paying the interest for the period of the payment holiday. Say you have an outstanding loan of Rwf 55 million with the bank. Your current monthly repayment is Rwf 1.2 million and it constitutes of Rwf 1 million as interest and Rwf 200,000 as principal. If you ask for a 3 months payment holiday on the principal, it means you will continue paying the interest of Rwf 1 million. In which case it is indeed a holiday as there is no extra financial cost to you besides extending your loan maturity date by the period of the holiday ie if your loan was to be repaid within 10 months, and you ask for a 3 months holiday, it will now be repaid within 13 months.

If however you opt for a payment holiday on your total monthly obligation, which is what most borrowers go for, there is a financial cost to you. The bank capitalizes the interest. This means that the bank adds the interest that you were supposed to pay during the holiday to the total amount of the outstanding principal that you owe the bank.  Say you have an outstanding loan balance of Rwf 55 million with the bank. Your current monthly repayment constitutes of Rwf 1 million as interest and Rwf 200,000 as principal. If you ask for a 3 months payment holiday on the total monthly obligation, it means you will pay nothing during the 3 months. But there is a financial cost to you. The total interest you were supposed to pay in the 3 months ie Rwf 3million will be added to your outstanding loan balance of Rwf 55 million. So you will now owe the Bank Rwf 58 million. 

And when the holiday is over, the bank will be charging you interest on Rwf 58 million not the original Rwf 55 million which you owed. Consequently, your monthly loan repayment of Rwf 1.2 million will increase after enjoying your holiday.

In light of the above, it is important to ask yourself if you really need the payment holiday in the first place.

Many borrowers’ incomes continue to be negatively affected by the effects of the Covid-19 pandemic on our economy. It therefore makes sense to consider requesting your bank to a payment holiday if you have been directly affected and are struggling to meet your financial obligations.

However, if you find that you still have sufficient surplus funds left then it may not be advisable to go for the loan restructuring. Or if you do, it may be advisable to go for a payment holiday option which only suspends the payment of the principal and you continue paying the interest. Ofcourse you will have to consider whether your surplus funds will be able to meet your current and future cash flow needs in case your revenues continue to dip.

Loan restructuring is meant to restore financial health and stability to those who are facing genuine cash flow issues and have absolutely no other option. It is best advised to avoid loan restructuring and continue repaying your monthly if you are able to.

Restructuring loans makes little financial sense due to the increased interest burden. Many borrowers will still find that they need to request for loan restructuring due to their current cash flow issues. Banks should endeavour to explain better to their borrowers the financial cost of this holiday so that they make informed decisions.  Otherwise, the borrowers will be in for a rude awakening when their ‘holiday’ comes to an end.

By Richard Balenzi Published : February 02, 2021

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