Definition
Forbearance, in the context of finance, refers to a temporary postponement of mortgage payments granted by the lender or creditor. It is an agreement made during a period of financial hardship for the debtor, allowing a delay or reduction in payments. It’s important to note that the debt isn’t forgiven, just delayed or reduced, and must eventually be fully repaid.
Key Takeaways
- Forbearance is a temporary postponement of mortgage payments. It is a form of payment relief granted by the lender or creditor in a period of financial hardship.
- Forbearance does not erase the amount you owe. Once the forbearance period ends, you must either repay all the missed or reduced payments at once, come up with a repayment plan, or in some cases, have the amount added to the end of the loan term.
- In periods of crises or economic downturn, lenders may offer forbearance periods which can help borrowers navigate financial difficulties. However, it’s not a long-term solution for those facing consistent financial struggles, given the debt eventually needs to be paid back.
Importance
Forbearance is a crucial term in finance, primarily because it addresses temporary hardship. It’s a special agreement between a borrower and lender that temporarily postpones, reduces, or suspends loan payments when the borrower faces financial difficulties.
During uncertain times, such as a major economic downturn or a pandemic, many borrowers may not afford to pay their loans. In such scenarios, forbearance becomes particularly significant.
This flexibility prevents the borrower from defaulting on their loan, protects their credit rating, and allows the lender to maintain a positive relationship with the customer. It, therefore, provides financial relief when it’s most needed, allowing for a smoother recovery when an individual or a company’s financial situation stabilizes.
Explanation
The essential purpose of forbearance is to provide temporary financial relief to borrowers during times of financial hardship. It is a tool that lenders and servicers can use to help borrowers to overcome short-term financial problems such as unexpected medical expenses, job loss, or other temporary financial setbacks.
Notably, during the forbearance period, the lender refrains from enforcing the full payment schedule, allowing the borrower to make reduced payments or even skipping payments for a specified time period. While interest typically continues to accrue during this period, late fees may be postponed or eliminated.
Forbearance is predominantly used in the context of mortgages, student loans, and other long-term loan agreements. It serves as a viable recourse when borrowers find it challenging to keep up with their contractual payment obligations due to temporary financial hardships.
Importantly, the use of forbearance can prevent the detrimental consequences of default, such as foreclosure in case of mortgage loans or adverse credit reporting. It doesn’t erase what a borrower owes, but it temporarily adjusts the repayment terms to make them more feasible until the borrower’s financial situation improves.
Examples of Forbearance
Student Loans: One of the most common examples of forbearance is in the context of student loans. If a borrower is experiencing financial hardship and unable to make their scheduled loan payments, they can apply for forbearance with their loan servicer. While in forbearance, the borrower’s monthly loan payments are reduced or eliminated. This can help prevent the borrower from defaulting on their loan, but interest will continue to accrue on both the principal and unpaid interest.
Mortgages: During the COVID-19 pandemic, many mortgage lenders have offered forbearance options to homeowners who have been economically impacted by the pandemic. This allows the homeowners to temporarily pause or make smaller mortgage payments. While this relieves some immediate financial pressure, it may increase the overall loan cost due to the accrual of interest.
Credit Cards: Some credit card companies may also offer forbearance, especially in cases of unforeseen circumstances like job loss, illness, or natural disasters. Rather than closing the account or charging late fees, the credit card company may allow the cardholder to pause or reduce their monthly payments for a specified period of time while they recover from their financial hardship. Interest will still be charged on the balance during the forbearance period.
FAQs on Forbearance
What is Forbearance?
A forbearance is a temporary postponement of mortgage payments. It is a form of repayment relief granted by the lender or creditor in lieu of forcing a property into foreclosure.
Who qualifies for a forbearance?
You might be eligible for a forbearance plan if you are experiencing temporary hardship. For instance, if your financial situation has been impacted by a disaster or a global pandemic, you might qualify for a forbearance.
Does forbearance affect credit score?
A forbearance will not directly hurt your credit score. However, it may indirectly impact your score by increasing your total debt or causing you to miss future payments.
What is the difference between forbearance and deferment?
While they both allow you to temporarily postpone payments, the main difference lies in interest accrual. Interest does not accrue during deferment (except for unsubsidized loans and PLUS loans) whereas it does during forbearance.
Is there a limit to how long you can be in forbearance?
Forbearance terms are typically up to 12 months. However, lenders may be willing to extend the forbearance period, depending on the borrower’s circumstances and the specific details of the loan agreement.
Related Entrepreneurship Terms
- Loan Modification: An agreement between the lender and borrower to change the terms of the mortgage in order to make payments more manageable.
- Delinquency: Failures to make loan payments when due.
- Mortgage Servicer: An institution or company that handles the day-to-day tasks of managing your loan.
- Default: The failure to repay a loan agreement as agreed.
- Deferment: A period during which repayment of the principal and interest of your loan is temporarily delayed.
Sources for More Information
- Investopedia: A comprehensive online resource dedicated to understanding finance and investing.
- Consumer Financial Protection Bureau: A U.S. government agency that ensures banks, lenders, and other financial companies treat consumers fairly.
- NerdWallet: Provides clarity for all of life’s financial decisions, including insights on forbearance.
- Bankrate: Creates and provides free, original, and objective content to help users make sound financial decisions.
