A forbearance agreement is contractual agreement where a lender agrees to postpone debt service payments for a specific period of time for a struggling borrower. Generally, forbearance agreements allow only short term payment delays, from a few days to a few months, but rarely longer.
Under a forbearance agreement for a mortgage loan, the lender agrees to not foreclose on a property if the borrower satisfies some consideration for the forbearance. That could mean a fee, a higher interest rate, or another concession. Forbearance agreements are also common with student loans, but are less common in other loan types.
What are a bank's forbearance guidelines?
Forbearance agreements are contracts, and as such vary from one case to another. They are negotiated based on a number of guidelines and considerations. For example, a home that is severely underwater gives leverage to the borrower, because a foreclosure would likely result in steep losses for the lender.
Lenders are more likely to agree to a forbearance agreement for borrowers that have a clearly defined, short term financial problem. The borrower could have fallen ill or been injured on the job, temporarily limiting their cash flow. If the borrower can show that their income will soon resume, the bank could be willing to agree to a forbearance.
At the end of the day, the bank simply wants the loan to be paid on time and the borrower wants to overcome their financial difficulty with minimal damage to their credit and finances. If the borrower can prove that payments are highly likely to resume after the forbearance period is over, then the bank is more likely to agree to the contract.
Forbearance agreements are not limited to mortgage loans
Any loan could in theory be subject to a forbearance agreement, not just mortgage loans. However, in practice the two most common loan types are mortgages and student loans.
Unlike mortgage loans, student loans do not typically have collateral that the lender can repossess. Most student loans in the U.S. are backed by the federal government or one of its agencies though, and because of that fact a student loan forbearance is not about protecting property, but about preventing a default that could result in even more damage to your credit score, wage garnishment, or other aggressive collection tactics available to the government.
There are specific guidelines in place defining the various types of student loan forbearance agreements. Borrowers can qualify for a forbearance as a result of illness, financial hardship, or by participating in certain government approved programs like medical residency, qualify under the teacher loan forgiveness program, and other very specific situations. The Department of Education's website is the best source of information on the most current guidelines and requirements.
Forbearance agreements are a difficult realty for many to face. However, a well-constructed forbearance agreement can be a win-win for both the borrower and the bank in an otherwise tough situation.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at [email protected]. Thanks -- and Fool on!
Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.