Updated: Apr 5, 2020
You’ve read it in the news, and social media has been abuzz with it.
You have been given a 6-month bank moratorium beginning 1st April 2020.
If you had any doubt, it was swept away when you received a text message or email from your bank confirming that they will not be taking any payments from you between 1st April to 31st September.
Global uncertainty in the face of Covid-19 has had you on the edge. You’re restricted at home. Your office is closed. Many people have lost their jobs or are taking pay cuts.
Businesses are drowning.
Not having to pay your loans for 6 months is certainly a relief. Hell, it’s the best news you’ve heard all year.
But wait a minute…
Is there a catch? It seems too good to be true.
What’s this about accrued interest during the moratorium? There’s talk that you may have to pay compounding interest.
Commentaries on social media are divided with some saying the moratorium is good for you and others saying it is the most expensive holiday you’ll be paying for.
You’re a little confused now. Is this moratorium good for you or not?
To make sense of all this, you must look at the bank moratorium with mathematical logic. As Sherlock Holmes would say,
“Crime (or in our case, opinion) is common. Logic is rare. Therefore it is upon the logic rather than upon the crime (or opinion) that you should dwell”
So, bring out your looking glasses. Let’s take a closer look at the logic behind this moratorium.
What’s a Moratorium in Banking?
We should start with clarity. Let’s look at the word “moratorium” first.
Bank Moratorium Definition
According to the Merrian-Webster dictionary, a moratorium is “a legally authorized period of delay in the performance of a legal obligation or the payment of a debt.”
Simply put, it is the suspension of an activity.
Bank moratoriums are more common than you may think.
Education loans for example, usually come with a moratorium. The student who takes the loan is not required to make any payments until she graduates and starts working.
Thus, the moratorium period of an education loan depends on the length of study.
Is Interest Charged During a Moratorium?
Interest is often accrued during the moratorium.
In the example of the education loan, interest would be calculated on the amount disbursed and added to the principal loan amount.
When the student finally starts working, her interest would be calculated on the total amount (principal + accrued interest).
In this instance, interest is paid upon interest accrued during the moratorium. This compounding effect causes the student to pay more in interest.
So a moratorium is not a cost-free holiday. There is an interest cost.
But is there any benefit to you, in spite of this interest cost? Let’s go deeper down the rabbit hole.
The Bank Moratorium in Malaysia: Why?
Let’s be clear. The banks were not eager to give you a moratorium. Suspending payments for 6-months would put a serious dent in their cash flow.
Bank Negara Malaysia (BNM) imposed this on all banks. For good reason.
The world is facing an economic crisis with no precedence. The global shutdown caused by Covid-19 is sending shockwaves through the economy.
Almost all businesses in Malaysia have shut down. The retail market is suffocating. The tourism industry is crippled. People are going to lose their jobs or incomes.
In a country where a third of its people live paycheck to paycheck, this is alarming. A mass default in loans can trigger the collapse of our financial system.
BNM made a smart pre-emptive move.
The 6-month moratorium was implemented with surgical skill.
Before announcing the moratorium, BNM lowered the statutory reserve requirement from 3% to 2%. Banks now needed to keep less reserves and could lend out more money. RM30 billion more to be exact.
Not only can banks profit from this but liquidity in the market has increased.
Prior to this, the OPR was also reduced. Twice.
A reduction in the OPR results in lower interest rates.
The resulting effect is more money in the market, and the cost of borrowing is cheaper.
Here's the thing about the economy. It’s about what people do. It’s the everyday transactions that all of us make. All these transactions are interconnected.
Therefore, if demand for goods and services drop significantly, a recession is triggered.
How do you keep demand from free-falling? Give people more disposable income. Enter the moratorium.
This 6-month moratorium is a lifeline to the economy and a stroke of genius.
Ok, but what is this moratorium going to cost you?
Moratorium Interest Calculation
Let’s look at an example.
Let’s say you have a mortgage of RM500,000 with the 1st repayment commencing on 1st April 2020 (the start of the moratorium). The loan is payable over a period of 30 years at an interest rate of 4%.
Your monthly repayment is RM2,387.
With the 6-month moratorium your payment commencement is deferred to 1st October 2020.
Interest accrues during the moratorium.
Therefore, at the end of the moratorium, you will owe RM10,000 in interest.
Now, if interest was not compounded during the payment period, your new monthly repayment amount would be RM2,415. An increase of RM28.
But if interest payments were compounded, your monthly payment would be RM2,435. A further increase of RM20.
For clarity, let’s look at the additional interest in total:
No compounding - RM10,000
With compounding - RM17,200
Whether interest is compounded or not, you pay more in interest with the moratorium. Fortunately, most banks in Malaysia have said they will not compound interest.
Your mortgage variables may be different from the example above, but keep in mind that exactly how much you pay in additional interest will depend on 2 things:
Whether interest is compounded or not
The number of repayments left on your mortgage
Before you roll your eyes up and write-off this moratorium, consider the next question.
What is the Real Cost of the Moratorium to You (and Should You Opt Out of It)?
On the surface, this moratorium is expensive.
Using the example above if you don’t have to pay your bank RM2,387 for 6 months, you’d have an additional RM14,322 in cash.
Assuming interest is not compounded, this extra cash is coming at a cost of RM10,000.
A whopping 70% of the additional cash.
Some therefore argue that the additional cash comes at too high a price.
But let’s put this in perspective.
Do you know how much you’d have actually paid for the RM500,000 house at the end of the 30-year mortgage period? Take a guess...
You’d have paid nearly RM860,000. (Was your guess close?)
That’s RM360,000 or 58% cost.
There’s more to this though.
The cost of a mortgage may seem high but because
you’re paying it over a long period of time, and
you build equity as the value of the house appreciates
the cost isn’t as exorbitant as it seems.
Money devalues over time because of inflation. At an inflation rate of 3% over 30 years, RM10,000 then is only RM4,120 now.
If your house averages an appreciation of 4% over a 30-year period, the equity built on the house wipes out the interest cost.
Now here’s where it gets interesting.
If you’re staying in your house, the absolute cost to you is minimal.
But if you have a tenant in your house, there is no cost to you. This moratorium is the best thing that could happen to you.
I’ve always maintained that a mortgage for a buy-to-let property is often an interest-free loan. That’s because your tenant is paying the interest cost.
Let’s use the same example we’ve been using above.
Over a 30-year period, your total interest is RM360,000. This is an average of RM1,000 per month in interest.
If your tenant is paying you RM2,000 per month, your interest cost is more than covered. That essentially means you have an interest-free mortgage.
Under these circumstances, a moratorium is fabulous!
But I’m really rich and I don’t need a moratorium you say?
How about this. Take the RM14,322 in additional cash and put it in an ETF like the S&P 500. The average return from the S&P 500 since its inception in 1926 to 2018 has averaged more than 10%.
This rate of return when compounded outweighs the interest cost.
You’d be losing money if you opt out of the moratorium.
How Do You Handle Tenants Asking for Discounts?
Let’s be amoral first and look at this purely from a contractual standpoint.
You're not obliged to give a discount.
You have a tenancy agreement and there is no mention of a moratorium in it. Rent is due on a specified day of every month unless there are extenuating circumstances provided for in the contract i.e the property is burned to the ground.
You can therefore say no to any request for a discount and that’s the end of the matter.
Now let’s look at it from an equitable standpoint.
Giving a moratorium or discount to your tenant will not make you worse off.
Let’s go back to our example above.
You’re paying RM2,387 in monthly installments and collecting RM2,000 in rent. Thus far you’ve had to pay an additional RM387 to your bank.
Now, you don’t have to pay your bank for 6-months. If you give a 6-month moratorium to your tenant, your net position is still better by RM387.
But what about the RM10,000 in accrued interest? Well, after the 6-month moratorium, your current tenant and future tenants will be paying it for you. Your real interest cost as long as you have tenants is zero. I’ve explained this above.
Some landlords argue that they’ll offer a discount on rent only to tenants who are in need of it.
There’s nothing wrong with this reasoning.
But you must keep in mind that the 6-month bank moratorium does not distinguish between borrowers who need it and borrowers who don’t need it. It is a blanket conferment.
If we’re being equitable, the same can be extended to tenants.
Additionally, how does a landlord determine whether a tenant is in need of financial assistance? Tenants can lie. Some may really need it but are too embarrassed to ask.
Ultimately, whether or not you decide to give your tenant a moratorium or discount is up to you. There is no right way.
You must know that offering a moratorium to your tenant will not necessarily make you worse off if you have a mortgage.
How you should treat requests for discounts depends on whether you have a mortgage or not. Let's look at the 2 possibilities:
1. You have a bank mortgage
The bank moratorium, improves your cashflow situation. The accrued interest is not really a cost to you if your future rental income covers the interest portion of monthly instalments. You can offer anything from a full moratorium to a small discount to your tenant during the moratorium period.
2. You don't have a bank mortgage
In this case, the moratorium does not improve or worsen your net position. By giving a discount on rent, you are worse off. You therefore shouldn't offer a discount unless you feel you can afford it.
As a precaution, don’t offer any discount or moratorium to your tenant until you think carefully about it. Ask for time, give it some thought and be equitable.
The Big Picture: It’s Good for You
The moratorium will benefit you if you have a mortgage. Even if you’re cash rich right now. There are mathematical grounds to support this argument.
It is a great move by the government because it will improve liquidity in the market, arrest the decline in demand for goods and services, and save the banking system from collapse.
You don’t have to be concerned about the accrued interest.
Inflation and the appreciation on your house value over time will offset this. In addition, if you have a tenant, there is probably no interest cost to you. Your current and future tenants will be taking care of this for you.
You are under no obligation to give a discount on rent during the moratorium. However, you are most likely not going to be worse off if you do. It is therefore equitable to extend either a moratorium or a discount to your tenant.
If you’ve been contemplating opting out of the moratorium, stop. Go through this post again and give it more thought.
Otherwise, enjoy the moratorium.