The grace period and the cliff at the end of it
A principal grace period means you pay interest only for an opening stretch, commonly six to twenty-four months, and begin repaying capital afterwards. Banks offer it for a good reason and borrowers accept it for a good reason. The problem is what it does to the month it ends, which on a typical loan is the same month the promotional rate ends.
Why the cliff is steeper than the numbers suggest
There are two effects, and they compound.
The first is obvious: you start repaying capital. The second is not: the capital now has to be repaid over a shorter period. A twenty year loan with twelve months of grace is not a twenty year loan with a late start. It is a loan that repays 2.4 billion dong over 228 months instead of 240, so every capital repayment is larger.
| No grace period | 12 months of grace | |
|---|---|---|
| Months over which capital is repaid | 240 | 228 |
| Capital repayment each month | 10,000,000 | 10,526,316 |
| Instalment in month 1 | 23,800,000 | 13,800,000 |
| Instalment in month 12 | 23,167,500 | 13,800,000 |
| Instalment in month 13 | 31,850,000 | 33,526,316 |
| Rise at month 13 | +37.5% | +142.9% |
| Total interest over the term | 2,663,630,000 | 2,799,100,000 |
| Peak share of a 55m income | 57.9% | 61.0% |
The month thirteen instalment more than doubles. And notice the third effect hiding in the table: during the grace period the balance never falls, so interest in month twelve is charged on the full 2.4 billion rather than on 2.29 billion. The grace period costs 135,470,000 dong in additional interest over the term, which on these figures is about four months of instalments.
When a grace period is the right call
It is a cash flow instrument, not a discount, and there are situations where cash flow is exactly the binding constraint.
- You are paying rent and the loan at the same time. Buying off-plan usually means servicing the loan for a year or more before you can move in. Interest only for that period is the difference between manageable and not.
- A known, dated increase in income. A spouse returning to work, a fixed term contract ending, a business reaching a milestone. Dated, not hoped for.
- A known, dated inflow. The sale of another property, a maturing deposit, an inheritance already in probate.
- Renovation before occupancy. The months when the money is going into the building rather than into the loan.
In every one of those cases the grace period is bridging a gap that has an end date you can name. If you cannot name the date, the grace period is not bridging a gap, it is deferring a problem.
When it is a warning sign
If the loan is only affordable because of the grace period, the loan is not affordable. This sounds obvious written down and is remarkably easy to miss in a branch, because every document in front of you shows the grace period payment. The test is whether the month thirteen instalment, at the floating rate, stress tested two points higher, fits your budget today. On the figures above that is 33,526,316 dong at 11.5%, and roughly 37,526,316 dong at 13.5%.
A useful discipline: during the grace period, pay the full post-grace instalment into a savings account anyway. If you can do it for twelve months, you have proved you can afford the loan and you have built an emergency fund at the same time. If you cannot, you have found out while it is still cheap to find out.
Three questions about the mechanics
- Is the term extended or is the amortisation compressed? A few banks extend the term by the grace period, so capital is still repaid over 240 months. That is a materially better deal and it is worth asking for explicitly. Most compress.
- Does the grace period end on the same date as the promotional rate? If both roll off in the same month, the two jumps stack, which is how you arrive at 142.9%. Ask whether they can be staggered by six months. Sometimes they can.
- Is interest capitalised or paid? In a true interest-only period you pay the interest each month and the balance stays flat. In a full deferral the interest is added to the balance, which then grows. The second is much rarer in home lending and much more expensive; confirm which you have.
Model it before you accept it
The loan inspector takes the grace period as an input and reports the jump it causes separately from the jump caused by the promotional rate ending, because the two often fall in the same month and lumping them together hides the size of each. Enter your own grace period, then look at the required payment in the month after it ends rather than at the one in month one. That single number decides whether the loan works.
The broader affordability question, including what share of income is survivable and what emergency fund the loan implies, is in how much can you actually borrow.