Forbearance

What is forbearance?

Forbearance is an agreement between a lender and a borrower to temporarily suspend debt payments. For mortgages, lenders may opt to foreclose on borrowers who are unable to make payments. To avoid a costly foreclosure, the lender and the borrower can negotiate a forbearance agreement to allow the borrower to catch up on payments. For student loans, forbearance postpones payments under certain hardship conditions; however, interest continues to accrue on the principal balance.

Deeper definition

Homeowners who fall behind on their mortgage payments can reach forbearance agreements to help them recover from short-term financial setbacks, such as job loss or temporary illness. If borrowers expect a permanent change in their financial situations, forbearance isn’t a viable option. Instead, they need to look at loan modifications, which permanently change the terms of a loan to make it more affordable.

During the forbearance period, the lender agrees to stop foreclosure proceedings and permit the homeowner to pay either a reduced payment or no payment. The terms of the forbearance agreement vary depending on the lender. Some lenders expect a lump sum payment by a certain date, while others permit a borrower to make larger monthly payments after the end of the forbearance period to pay off the overdue amount.

Borrowers who have federal student loans can receive deferments or forbearance to temporarily stop making payments or reduce payments under certain conditions. With a deferment, the borrower may not be responsible for paying interest that accrues during the deferment period. With forbearance, the borrower is responsible for paying the interest that accrues during the forbearance period.

Forbearance example

Barbara, who owns a two-bedroom condo, discovers she will need to undergo emergency surgery and expects to miss three or four months of work. She has little money in savings and has only enough sick time to cover a month’s worth of salary.

While out of work, Barbara misses two mortgage payments and falls $2,000 behind on her mortgage. She contacts her lender in order to discuss a forbearance agreement, and the bank agrees to suspend the payments until Barbara is back at work. Once the forbearance period ends, the bank requires the homeowner to pay an extra $200 a month, in addition to her regular mortgage payment, to cover the loan arrears.

Concerned that you’re unprepared for a financial emergency? See how changing your spending habits can help your savings account.

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