What is Forbearance?
Forbearance is a term that refers to the temporary reduction or postponement of payments, such as for loans or mortgages. It happens when the lender grants the borrower momentary relief from paying off their debt due to hardships such as unemployment, injuries, illnesses, or natural disasters.
If you are a borrower and seek assistance in financial hardship, you can consider options where you can request forbearance. Although forbearance allows you to pay off your financial obligations at a later date, you will still need to repay any reduced or missed payments in the future. Specific terms of payment relief, such as interest payments and the length of the loan, must be negotiated between the lender and borrower.
As a result of the COVID-19 pandemic, borrowers have new options for obtaining forbearance, although those are likely to expire in the future.
- Forbearance is a temporary postponement of loan payments granted by a lender instead of forcing the borrower into foreclosure or default.
- The terms of a forbearance agreement are negotiated between the borrower and the lender.
- The borrower must demonstrate the need for postponing payments, such as financial difficulties brought on by a major illness or the loss of a job.
- Mortgagors whose loans are backed by government programs and are affected by COVID-19 may qualify for relief.
- Forbearance is available for federal student loans for borrowers affected by COVID-19 until Jan. 31, 2022.
Most homeowners can temporarily pause or reduce their mortgage payments if they’re struggling financially. Although it is primarily used for student loans and mortgages, forbearance is an option for any loan. It gives the debtor extra time to repay what they owe.
Forbearance is when your mortgage servicer or lender allows you to pause or reduce your mortgage payments for a limited time while you build back your finances.
For most loans, there will be no additional fees, penalties, or additional interest (beyond scheduled amounts) added to your account, and you do not need to submit additional documentation to qualify. You can simply tell your servicer that you have a financial hardship.
The lender may approve a total reduction of the borrower’s payment or only a partial reduction, depending on the extent of the borrower’s need and the lender’s confidence in the borrower’s ability to catch up at a later date.
Forbearance doesn’t mean your payments are forgiven or erased. You are still obligated to repay any missed payments. Before the end of the forbearance, your servicer will contact you about how to repay the missed payments.
In some cases, the lender may grant the borrower one of several options. These include:
- A full moratorium on making payments for a period of time
- Requiring the borrower to make interest payments but not pay down the principal
- The borrower paying only part of the interest, with the unpaid portion added to their total debt—a process known as negative amortization
Forbearance may be mandated by law. For example, the federal Coronavirus Aid, Relief, and Economic Security (CARES) Act, which was passed and signed into law in 2020 to address the economic fallout from COVID-19, included provisions for student loan forbearance. Some state governments also enacted regulations related to forbearance during the pandemic. The law also made provisions for mortgage payment forbearance for struggling homeowners during the pandemic.
How to Apply for Forbearance
Borrowers should contact their lenders or loan servicers to apply for forbearance on student loans or mortgages. In most cases, they will need to demonstrate a need to put off payments, such as financial difficulties associated with a significant illness or job loss.
Since forbearance agreements are negotiated, lenders have a lot of discretion when it comes to deciding whether or not to offer help and to what extent if they do. Borrowers with a consistent payment history are more likely to be successful.
For example, a borrower who worked at the same company for 10 years without ever missing a mortgage payment is a good candidate following a layoff. This borrower would be particularly likely to receive forbearance if they are highly skilled and can land a comparable job within a reasonable period of time. A lender is less likely to grant forbearance to a laid-off borrower with a spotty employment history or a track record of missed payments.
Do I Qualify for Forbearance?
Depending on who your lender is, there may be standards that you need to meet or situations that you need to demonstrate before qualifying for payment relief, such as:
- Financial hardship: Layoffs, reduced income, or failure of a business
- Medical hardship: Serious illness or long-term disability
- Disaster: Natural disasters or life-threatening accidents
- Separation from a primary income earner: Divorce or death of a family member who is the primary income earner in the family
After determining your qualifications, you may also need to fill out an application. You are recommended to speak to your lender or service provider for additional details about the specific terms of the loan.
Types of forbearance in US
Examples of the types of forbearance which lenders may potentially consider include:
- A full moratorium on payments
- Reduced payments:
- Above Interest-Only (termed Positive-Amortising)
- Below Interest-Only (Negative-Amortising)
- Interest Only
- Reduced interest rate
- Split Mortgage
It needs to be understood that the type of forbearance being granted is being provided based on the customer’s individual circumstances. For example, borrowers in short-term financial difficulty would be more likely to be approved of either a (short term) full moratorium or negative-amortizing deal than customers in long-term financial difficulty, where the lender would at all times seek to ensure that the capital balance continues to be reduced (via an amortizing forbearance arrangement).
Negative-amortizing forbearance arrangements are only suitable as short-term deals since failure to pay interest timely and/or on the whole loan balance is effectively is additional borrowing. It is important to note that depending on the parameters of the agreement consumers can be held fully responsible for paying the entire amount due after the duration of the forbearance.
Some exceptions to this are where a reduced rate was given (where the possible intention here to reduce the capital balance as quickly as possible, thereby reducing the loan to value) or where the type of forbearance is for the lifetime of the loan, i.e. a split loan where 1 part of the loan is parked until the expiry date, with the intention that at that time a suitable repayment vehicle (say, sale of the asset) is in place for the repayment of the loan in full.
Benefits and Risks of Forbearance
Forbearance gives borrowers a chance to pause payments for loans, mortgages, or credit cards, helping borrowers avoid defaulting on their loans. It is more beneficial to request payment relief rather than risk defaulting on loans because forbearance does not impact your credit score, whereas default would cause a negative impact.
Forbearance also means that you can avoid foreclosure for your inability to pay missed loan repayments so that you can prevent your personal assets from being seized by your lender during the period for payment relief. It also allows you to pay more critical expenses, such as rent, utilities, or medical fees.
However, there are also risks in the borrower’s inability to satisfy the terms of forbearance, negatively impacting their credit score. Additionally, the payment relief period will continue to accrue even more interest that is to be paid after the period is over. The accrual of interest will be added to your existing balance, which may cause even greater financial hardship.
What Happens After Forbearance Ends?
If you are unable to resume making regular payments, your servicer or lender should evaluate you for all available loss mitigation options. Upon completion of the forbearance, the lender shall communicate with the borrower and determine if the borrower is able to resume making regular contractual payments.
To be clear, forbearance doesn’t mean the debt goes away. You still have to repay it. But how you repay that debt depends on your loan and the options the lender or creditor is offering. Forbearance repayment can look very different depending on your lender. Here are some of the ways you might see lenders ask for repayment:
- As a lump sum due at the end of the forbearance period
- As an additional charge on top of your existing monthly payments over a set number of months
- As a lump sum or additional payment added to the end of your loan
Just as your eligibility for debt forbearance may differ between different lenders, so might the options available for repayment of those deferred payment agreements. The most important thing is that you ask your lender about the options available to you, and make sure you get the final agreement in writing and signed by the lender.