Everything You Need to Know About the Grace-Period Loan
The Israeli family rents an apartment and is buying a new-build from a developer. The apartment won't be ready any time soon. As luck would have it, for a while they'll have to pay both rent and mortgage payments — until their place is ready. The family is struggling to cover the mortgage and the rent at the same time.
What can they do? Before moving back in with their parents, downsizing to a cheap, run-down flat, or renting out one of the rooms to a tenant, the bank can help. The Israeli family most likely needs to add a grace-period loan to their mortgage mixture.
What is a grace-period loan?
- Stage one: interest payments only, with no principal repayment
- Stage two: repayment of both interest and principal
A grace-period loan allows a reduced monthly payment. During the grace period, we pay only the interest on the loan. The principal — the amount we borrowed from the bank and have to repay — doesn't go down. From the end of the grace period until the loan is paid off, we cover both principal and interest through larger payments.
The Israeli family wants to borrow 500,000 NIS in a loan for a term of 15 years. The annual interest rate on the loan is 3%, meaning the monthly interest charged on the debt is 0.25%.
Under the annuity amortization schedule (Spitzer), the monthly payment on the loan is 3,452 NIS.
You can calculate the monthly payment using the PMT function in Excel: pmt(3/1200,15*12,500000)=
The Israeli family is struggling to pay the mortgage alongside the rent, and is considering adding a grace-period loan to the mortgage mixture for the entire construction period. If they add a three-year grace period, for 36 months they'll pay only interest. The monthly interest payment will be:
As noted, in the first stage of a grace-period loan the principal doesn't go down. So after each monthly payment, the outstanding principal balance is still 500,000 NIS.
What kinds of problems can be solved with a grace-period loan?
If you're currently short on cash flow to cover the mortgage, but your cash flow is expected to improve in the near future (within three years) — a grace-period loan is a good fit, and it's worth including it in your mortgage mixture.
- The improvement in cash flow can come from an increase in monthly income, for example:
- Moving to a full-time position
- Completing a residency or internship
- A change of role
- Or from a reduction in financial obligations, such as:
- Ending rent payments running alongside the mortgage
- Finishing car-loan or credit-card payments
- Children leaving private daycare, etc.
What happens when the grace period ends
"Sometimes the party ends — lights out." Up to now we haven't reduced the principal at all, so its balance hasn't changed. But debts have to be repaid, and we'll start paying ours down at the end of the grace period.
At the end of the grace period (in our example, after three years), our monthly payment gets recalculated. We'll need to repay a debt of 500,000 NIS over 12 years (that's 144 months — three years less than the original loan term) at an annual interest rate of 3%. The monthly payment will be 4,138 NIS.
You can calculate the monthly payment using the PMT function in Excel: pmt(3/1200,12*12,500000)=
After the grace period, the payment (4,138 NIS/month) will be higher than the payment on a loan with no grace period (3,452 NIS/month). We can see that deferring principal payments by three years raised the monthly payment by 19.8% relative to a regular loan settled on an annuity amortization schedule (Spitzer). That makes perfect sense — we have fewer years (12) to repay the principal than the original 15-year loan.
Grace-Period Payment Calculator
Monthly repayment without a grace-period loan: 0 NIS
Calculations are based on an annuity amortization schedule.
📊Deep dive — how to calculate the increase in the monthly payment in stage two relative to a regular Spitzer loan
You can calculate analytically the expected increase in the monthly payment:
Where:
- R = monthly interest rate
- N = total number of months of the loan
- G = number of months of the grace period
A key weak point of the grace-period loan — at the end of the period, the monthly payment jumps significantly. It's important to prepare for this in advance, because the end of the grace period brings a sudden jump in the payment that can strain the monthly budget.
Which loans can include a grace period?
A grace period can be added to any loan except the government-subsidized mortgage (ZAKAOT). So if we're stretched thin on repayments, it's worth giving up the ZAKAOT despite its attractive interest rate.
What is the cost of a grace period?
First, let's calculate the total interest on the loan without a grace period. For this we use the Excel CUMIPMT function. The function lets us calculate the interest costs on a loan that follows the annuity amortization schedule (Spitzer).
We don't recommend relying on this function for mortgage planning — it isn't fully suited to the purpose and can lead to incorrect results.
Excel formula to calculate total interest payments — from month 1 to month 180: cumipmt(3/1200,15*12,500000,1,180,0)=
Total interest payments are 121,523 NIS. In other words, we repay 1.24 NIS for every NIS we borrow.
Now let's calculate the cost of paying off the mortgage with a grace-period loan in the mixture. In the first stage, which lasts 36 months, we pay only the interest and the principal doesn't go down. Over the 12 years that follow, we calculate the loan costs under the annuity amortization schedule (Spitzer).
Excel formula to calculate total interest payments with a grace-period loan: (36*500000*0.25%)+cumipmt(3/1200,12*12,500000,1,144,0)
Total interest payments are 141,006 NIS — that is, 1.28 NIS for every NIS we borrow.
In the case discussed, using a grace period increased the cost of the mortgage by 16.03%, which is almost 20,000 NIS.
How can a grace-period loan be used to improve the mortgage?
We saw that using a grace period has two drawbacks — a higher initial payment than a regular loan and a greater cost in interest. Is that a reason to avoid a grace period at all costs? Absolutely not!
In fact, this loan has such a bad reputation that people flat-out refuse to use it. But if we know our cash flow is about to improve in the near future, it's worth using it anyway. It will save us many years and a lot of money in interest.
- A couple needing a loan of 500,000 NIS at an annual interest rate of 3%.
- Current repayment capacity: 3,000 NIS per month.
- After 36 months, the monthly repayment capacity will improve to 5,000 NIS per month.
Let's look at two different options:
Alternative A: Take a mortgage with a low payment that matches our current financial capacity.
Alternative B: Take a mortgage with a grace period, then raise the monthly payment at the end of the grace period to match our updated repayment capacity.
The savings:
- Shortening the loan term by 6 years (18 years → 12 years)
- Saving 93,416 NIS in interest (147,701 − 54,285 = 93,416)
A huge improvement!
In short, the grace-period loan is one tool in our financial toolbox, designed to help us bridge a stretch when cash flow is tight. If you need help at the start of the mortgage term, it would be a mistake not to use it. It's absolutely worth taking a grace period on a mortgage if you can pay more later on!
Want to see exactly how much a grace period costs and how it affects the amortization schedule? Check it out in our mortgage calculator.