Forbearance

What Is Forbearance?

Forbearance is a temporary agreement between a borrower and a lender that allows for a pause or reduction in loan payments, typically in response to a borrower experiencing financial hardship. This financial tool falls under the broader category of Debt Management, offering relief from immediate payment obligations. While payment obligations are paused or reduced during forbearance, the underlying debt and accrued interest typically remain. The primary purpose of forbearance is to prevent more severe outcomes, such as foreclosure for a mortgage or default on a student loan.

History and Origin

Forbearance has long been a recognized practice in lending, allowing creditors to work with borrowers facing temporary financial difficulties rather than immediately pursuing harsher remedies. Its historical application has generally been for short-term crises, providing a bridge for borrowers to regain financial stability. A significant expansion of forbearance provisions occurred during the COVID-19 pandemic. The Coronavirus Aid, Relief, and Economic Security (CARES) Act, enacted on March 27, 2020, provided widespread forbearance options for federally backed mortgages, enabling borrowers to request a temporary suspension or reduction of payments due to hardship related to the pandemic without needing extensive documentation.¹²,¹¹ This legislation marked a large-scale, mandated implementation of forbearance, highlighting its role as a critical tool during economic crises.

Key Takeaways

• Forbearance provides temporary relief from loan payments, allowing borrowers to pause or reduce their monthly obligations.
• It is a tool used to prevent loan default or foreclosure during periods of financial distress.
• Forbearance does not forgive the debt; missed payments must still be repaid, often through a lump sum, increased future payments, or an extended loan term.
• The terms of a forbearance agreement are negotiated between the borrower and the loan servicer.
• While offering immediate relief, forbearance can have long-term implications, including continued interest accrual and potential impacts on credit if not managed properly.

Interpreting Forbearance

Forbearance should be interpreted as a short-term, temporary solution for managing financial distress, not a long-term strategy for avoiding debt. When a lender grants forbearance, they are agreeing to "hold back" their right to demand full payments or initiate collections actions. This pause provides borrowers with crucial time to address the underlying causes of their financial hardship, such as job loss or medical emergencies. It is critical for borrowers to understand the specific terms of their forbearance agreement, including how missed payments will be repaid, whether interest will continue to accrue, and the duration of the forbearance period. Failure to understand these terms can lead to significant financial burdens once the forbearance period ends, potentially necessitating a repayment plan or loan modification.

Hypothetical Example

Consider Sarah, who has a $250,000 mortgage with a monthly payment of $1,200. Due to an unexpected medical emergency, Sarah is temporarily unable to work and faces a significant reduction in her income, leading to financial hardship.

Sarah contacts her loan servicer and explains her situation. After reviewing her case, the servicer offers her a six-month forbearance period. During this time, Sarah's monthly mortgage payments are paused. While she isn't making payments, her $250,000 principal balance still accrues interest as per her loan agreement.

After six months, Sarah returns to work, and her income stabilizes. She then works with her servicer to determine how to repay the $7,200 in missed payments ($1,200 x 6 months) plus the accrued interest. Her options might include:

1. Lump-sum payment: Paying the entire $7,200 plus interest immediately.
2. Repayment plan: Adding an extra amount to her regular monthly payments over a set period until the missed amount is covered. For example, paying an additional $200 per month for 36 months.
3. Loan modification: Restructuring the loan, potentially extending its term to spread out the missed payments and accrued interest, which might slightly increase the total loan cost but keep monthly payments manageable.

This example illustrates how forbearance provides temporary relief, but the borrower remains responsible for the full amount eventually.

Practical Applications

Forbearance is primarily applied in situations where borrowers face temporary financial challenges that impede their ability to make scheduled loan payments. Its most common applications are:

• Mortgage Loans: Homeowners experiencing job loss, illness, natural disasters, or other unforeseen economic disruptions may seek mortgage forbearance to avoid foreclosure. During the COVID-19 pandemic, a significant number of individuals with mortgages utilized forbearance, with 16% of borrowers entering forbearance at some point between April 2020 and December 2021.¹⁰
• Student Loans: Borrowers struggling to manage their student loan obligations can often request forbearance. This can provide relief during periods of unemployment or unexpected expenses, though interest typically continues to accrue on both subsidized and unsubsidized loans during forbearance, increasing the total amount owed.⁹
• Other Consumer Loans: While less common than for mortgages or student loans, forbearance may also be offered for personal loans, auto loans, or other forms of debt depending on the lender's policies and the borrower's circumstances.

The Consumer Financial Protection Bureau (CFPB), a U.S. government agency, provides extensive information and guidance on mortgage forbearance, helping consumers understand their rights and options when facing payment difficulties.⁸

Limitations and Criticisms

While forbearance offers a valuable lifeline during financial distress, it comes with several limitations and potential drawbacks. A primary criticism is that forbearance is not loan forgiveness; borrowers are still obligated to repay all missed payments, often with accrued interest. This can lead to a larger total loan amount and potentially higher future monthly payments once the forbearance period ends.⁷,⁶

Another significant concern is the potential impact on a borrower's credit score. Although many forbearance programs, especially those enacted during widespread crises like the CARES Act, aimed to prevent negative credit bureau reporting for compliant agreements, improper reporting or failing to adhere to the forbearance terms can still negatively affect creditworthiness.⁵,⁴ This can make it more challenging for borrowers to obtain new credit or favorable terms for refinancing in the future.

Furthermore, if a borrower's financial situation does not improve sufficiently by the end of the forbearance period, they may find themselves in the same or even worse predicament, facing larger payments or the threat of foreclosure or default. The Consumer Financial Protection Bureau (CFPB) has issued rules to help borrowers transition out of forbearance, aiming to ensure they have time to explore options like loan modification before foreclosure actions can begin.³ However, these protections don't negate the underlying challenge if a borrower's long-term affordability issues remain unresolved.

Forbearance vs. Deferment

Forbearance and deferment are both options that allow borrowers to temporarily postpone loan payments, primarily used for student loans and sometimes mortgages. The key difference lies in how interest accrues during the pause. In forbearance, interest typically continues to accrue on the outstanding loan principal during the non-payment period. This means that when the forbearance period ends, the borrower will owe more than the original loan amount, as the accrued interest is added to the principal balance, leading to a higher total repayment. With deferment, particularly for certain types of federal student loans (like subsidized loans), the government may pay the interest that accrues during the deferment period. This prevents the loan balance from growing, making deferment generally more advantageous than forbearance if a borrower qualifies. However, eligibility for deferment is often more restrictive, based on specific circumstances such as enrollment in school, unemployment, or economic hardship, whereas forbearance is typically more widely available but with the trade-off of accruing interest.

FAQs

What is the main benefit of forbearance?

The main benefit of forbearance is that it provides temporary relief from making loan payments, helping borrowers avoid default or foreclosure during times of financial hardship. It offers a crucial period to stabilize finances without immediately damaging one's credit score.

Does forbearance hurt your credit?

Not necessarily. During programs like those under the CARES Act, compliant forbearance agreements generally do not negatively impact your credit score because the loan is reported as "current." However, if a borrower does not adhere to the agreed-upon terms or if the forbearance is not properly reported by the loan servicer, it could still show up as a missed payment and harm credit.

Do I have to pay back missed payments after forbearance?

Yes, forbearance is not loan forgiveness. You are still responsible for repaying any payments that were paused or reduced during the forbearance period. Your loan servicer will work with you to establish a repayment plan, which might involve a lump-sum payment, increased monthly payments, or a loan modification to extend the loan term.

How long can forbearance last?

The duration of forbearance varies depending on the loan type, lender policies, and specific circumstances. Historically, forbearance periods might range from a few months up to a year. During the COVID-19 pandemic, the CARES Act allowed for federally backed mortgage forbearance for an initial period of up to 180 days, with the possibility of an extension for another 180 days upon request.²

Can I get forbearance if I'm already behind on payments?

In many cases, yes. Forbearance is often intended to help borrowers who are already struggling to make payments or are on the verge of missing them. For instance, under the CARES Act, borrowers with federally backed mortgages could request forbearance regardless of their delinquency status.¹ It's always advisable to contact your loan servicer as soon as you anticipate financial difficulty.