Have you been affected by COVID-19? Not physically – financially. Did you lose your job? Did your company cut back on your hours? Are you a homeowner and you’re finding it increasingly difficult to pay your bills on time? Then you might need a forbearance.
What is a forbearance?
On March 27, 2020, President Trump made the CARES Act (Coronoavirus, Aid, Relief and Economic Security Act) into law. This act included provisions for homeowners experiencing financial hardship due to the coronavirus pandemic. These homeowners could enter into a “forbearance agreement” with their lender or servicer and not have to make their payments for anywhere from 90 to 180 days.
Who can get a forbearance?
According to the CARES Act, any homeowner with a federally backed mortgage can request a forbearance for up to 180 days.
What is a federally backed mortgage?
FHA loans and VA loans are federally backed mortgages.
What if you don’t have a federally backed mortgage?
Your lender may still allow you to enter into a forbearance agreement.
How do you enter into a forbearance agreement?
First, ask yourself if you are truly experiencing financial hardship. If you are able to make your mortgage payment, you should do so. But if you are experiencing financial hardship due to the coronavirus pandemic, contact your lender or servicer (whoever you make your payments to) and ask about entering into a forbearance agreement.
Does a forbearance cost anything?
No. Your lender or servicer is prohibited from charging any additional fees, penalties or interest (beyond the interest you would normally pay).
What kind of documentation is required to prove financial hardship?
None (other than your statement that you are experiencing financial difficulty due to COVID-19).
How does a forbearance work?
Once your lender or servicer has agreed to let you enter into a forbearance agreement, they will work with you to construct a plan so you can skip a certain number of payments then make them up later.
Are the missed payments due when the forbearance is over?
Not necessarily. Making a lump sum payment for the missed payments is one option. Another option would be to spread the missed payments over the remaining payments on your loan. A third option would be to add the missed payments on to the end of your loan.
What is the best way to pay back the missed payments?
That depends on your situation. Let’s say your mortgage payment is $1,000 per month. That $1,000 payment covers the principal and interest on your loan. Your servicer agrees to let you skip making payments for a certain period of time as long as you pay it back through one of three payment options.
Option 1: Make a lump sum payment at end of forbearance period. With this option, you would be able to skip your payments for six months, then on Day 181, you would have to write a check to pay back the missed payments. How much would that check be for? Not just $1,000 x 6 or $6,000. Allowing you to pay $6,000 would mean your lender had “stopped the clock” on the interest that accrues on your loan every month. But that’s not what happens. No matter what option you choose, your loan is still accruing interest. Another way to think about it is to understand the amortization schedule of your loan. Every month, your payment of $1,000 covers principal and interest. In the beginning, most of your payment goes to interest. Toward the end of your loan, most of the payment goes to principal. If you are allowed to make a payment of zero dollars for six months, you still owe the interest you should have paid during those months. Therefore, you would owe not only $6,000 for the missed payments, but also the interest that had accrued during that time.
How much would interest would you owe? That depends on your loan — the rate, the original balance, and most importantly, where you are in the overall term of the loan. If you just got your mortgage, most of your payments go to interest. Whenever you pay less than the required amount to cover debt service (interest) on your loan, you are incurring negative amortization or making your principal balance rise (not decrease). Before you choose this option, ask your servicer how much interest you would owe in addition to the missed payments.
Option 2: Reduce your payments initially, then pay more to catch up later (payment reduction spread out over twelve months). If your regular mortgage payments were $1,000 per month, twelve months of those payments would come to $12,000. Instead of your regular monthly payment of $1,000 per month, your servicer would allow you to pay 50% of that figure or $500 for three months. At the end of three months, you would have paid $1,500 (whereas before the forbearance, you would have normally paid $1,000 x 3 or $3,000). Therefore, starting in Month 4, you would make catch up payments of $1,166.67 for the next nine months to cover the balance due. But this amount is not enough to cover the accrued interest. Ask your servicer how much more you would need to pay to pay back the interest portion.
Option 3: Add the missed payments to the end of your mortgage. Your servicer could allow you to skip payments for up to one year. You would add the missed payments on to the end of your mortgage loan. So for example, if you took out a 30-year fixed rate mortgage in 2020, and your servicer allowed you to skip payments for 12 months, your loan would be paid off in 2051 instead of 2050. But the payments may be higher than normal to cover the accrued interest. Make sure you understand exactly how much you will have to pay.
I called my servicer and was on hold for almost an hour. Can I just skip my payments?
No. As you can imagine, many people are in the same situation as yourself, so servicers are swamped with calls. If you just stop making your mortgage payment without a formal forbearance agreement with your servicer, your payments will be recorded as late, which will hurt your credit score.
With a forbearance agreement, does my credit score go down?
No. Lenders and servicers will not report your mortgage as being late if you have entered into a forbearance agreement. But before you enter into one, make sure your lender or servicer confirms this for you in writing.
Is a forbearance agreement the same as a loan modification?
No. A forbearance agreement is temporary. A loan modification is permanent.
What is a loan modification?
A loan modification is when you ask your servicer if you can modify the terms of the loan. People usually request a modification when they are having difficulty making the original payments on time and they don’t anticipate being able to make the payments in the future. Modification agreements often result in reducing the interest rate and/or extending the term.
Is there any downside to a forbearance agreement?
Yes, there is. Having the option to skip payments and not have it reflect on your credit report seems like a win-win for the borrower, but in reality, those skipped payments end up costing you more than if you were able to stay on the regular payment schedule of your original mortgage. So if you can make your payments, continue to make them. If you have no other option than a forbearance agreement, then enter into one, but make sure to ask the right questions and go in with your eyes open.