Understanding Forbearances

Insights» Legal Insights

July 1, 2020by Melissa Martorella

A forbearance is the process of offering borrowers a temporary reduction in the amount they pay on their regular installments or a periodic deferment of mortgage payments. Debtors opting into forbearance agreements will be obligated to repay the remaining or deferred amounts back.

A forbearance is a tool implemented to assist borrowers that are experiencing financial hardship due to circumstances such as natural disasters, unemployment, or unexpected injury. This form of assistance will not eliminate the amount owed on the affiliated mortgage, as the borrower will sign an agreement obligating them to repay the loan in a specific time frame.

Forbearances can range from a fairly straightforward arrangement with your borrower (a temporary payment deferral, as an example), to a complex agreement to help a borrower navigate through a loan default (including staged payments, requirements to sell loan collateral, or the addition of new collateral or guarantors).

Receiving Forbearance Requests

The forbearance process is inherently complex—as each forbearance agreement is unique relative to the given financial situation of the borrower and how their respective lender chooses to accommodate their reduced ability to make timely payments. Factors that can influence the specific details of forbearance plans include the type of mortgage, the applicable owner or investor requirements of the given loan, and lender policies.

As the mortgage lender, there are a number of potential approaches that can be used to provide viable solutions to suit the borrower’s specific needs. The following is a brief overview of some forbearance options to consider implementing when receiving forbearance requests:

Option #1: Deferred Payments—Repaid During Existing Mortgage

In this type of forbearance agreement, borrowers are permitted to temporarily cease submitting payments for a predetermined length of time but are required to pay back the entire outstanding balance immediately when their payments become due again. Lenders should be cognizant that borrowers will be facing a substantial bill that will be due all at once. To illustrate, if a lender permits a debtor to pause mortgage payments for six months, at the end of that window, the debtor will owe all six of the missed monthly payments in the one month when payments restart. Additionally, interest on the deferred payments will continue to accrue until they are eventually repaid.

Option #2: Deferred Payments—Repaid at Mortgage End

This forbearance structure allows the borrower to defer payments for an agreed upon forbearance period and then the total deferred amount is repaid by either tacking it on to the end of the mortgage loan or by the borrower taking out another separate loan. Lenders should bear in mind that loan extensions will either result in the borrower having an additional period of time after the expiration of the existing mortgage to repay the deferred amount or having a balloon payment in the form of a separate loan due at the end of the current loan. Interest on the deferred amounts will continue to accrue until they are repaid.

Option #3: Reduced Payments

This form of forbearance structure permits borrowers to reduce their monthly mortgage installment by a predetermined percentage for a given period of time. Following this initial forbearance window, borrowers are afforded one year to repay the aggregated reduction amount. Mortgage providers should note that the reduction will be evenly distributed over the course of an entire year and paid proportionally in addition to the regular monthly amount. That means that the borrower’s total monthly mortgage installment will be significantly higher for a one-year period. For example, if a borrower reduced their $500 monthly payment by 50% for three months, starting in the fourth month they would be required to pay $562 ($500 + $750/12) every month for the following 12 months. Furthermore, interest on any lowered payments will continue to accrue until they are repaid.

These are just a few examples of forbearance options a lender has when a borrower is struggling to make the payment obligations under a loan. Lenders have the ability to be extremely creative when they draw up forbearances with their borrowers, and case base repayment plans on the borrower’s new (or temporary) financial condition. Lenders should take care to evaluate the borrower anew when underwriting the forbearance terms so that the agreement is reasonable based on the conditions of the parties. A forbearance is a great middle ground option when borrowers are in default but the lender does not want to foreclose or otherwise accelerate the loan.

If you have questions about whether to offer a forbearance or how to structure its terms, Geraci Law Firm is here to help. Our team of experts is able to walk you through various options to make sure the terms of your agreement work for you and your borrowers. Reach out here.