Mortgage Forbearance Agreement

The U.S. housing market underwent years of prosperity from the mid-2005 until the crash of the 2008 financial crisis, where mortgage rates plunged and caused devastating effects on the housing market.

Many lost their homes; others struggled, some saw an opportunity, but moreover, lessons were learned.

Mortgage rates are a quintessential determinant of the real estate mortgage as mortgage rates correlate to loan agreements between a financial institution and a lender who seeks to purchase a home or other real estate asset.

As for all other investments and financial instruments, tracking the interest rates necessary upon the mortgagor is crucial in understanding the obligations of both the lender and the mortgagor.

Economics 101 suggests that people should be less interested in purchasing immovable property (real estate) like houses when there is an increase in mortgage rates. This, as a result, leads to a lower demand for real estate, causing real estate prices to fall.

On the other end of the spectrum, when mortgage rates drop, a rush of potential homeowners flood the market, increasing the demand along with their prices.

A mortgage is a security used as a relief form of an upfront payment. Borrowers, or the mortgagor, engage in mortgage contracts to pay the costs proportionally over a period (typically 25 years or so).

The lender or mortgagee should evaluate and competently comprehend a mortgagor's creditworthiness. They may also ascertain the same by appraising their credit scores and income sources; this aids in eliminating credit risk.

Nonetheless, the complete elimination of financially adverse circumstances is not possible. Unexpected events could hinder the capability of the mortgagor to repay their mortgage obligations.

• Short-term unemployment
• Health issues

If a mortgagor (or buyer) defaults, a mortgagee (lender/seller) can agree to ease their current obligation.

Mortgage Forbearance Agreement, whereby a debtor is offered temporary relief from their obligations, is a common mechanism used upon default of a mortgagor.

What Is A Mortgage Forbearance Agreement? 

When a borrower fails to execute their commitment, the lender can either sue the borrower for a contract breach or foreclose the contract and reclaim the property. Alternatively, the borrower could approach the lender to request temporary relief from payments.

An agreement between the mortgagee and mortgagor to enforce such mortgage payment plan as an alternative to the mortgage foreclosure is known as the Mortgage Forbearance Agreement.

This agreement creates a forbearance period where the mortgagor is relieved from their mortgage obligations. When a forbearance period ends, the mortgagor is indebted to the mortgage contract and must finance the loan till the principal arrears and interest are repaid.

The forbearance period is short-term and lasts for approximately three to six months. Although mortgage contracts remain suspended in operation momentarily, interest still continues to accrue.

While enforcing this agreement, the mortgagor and mortgagee agree to restructure the loan. The mortgagee agrees to conditions including, but not limited to:

• Suspension or reduction in mortgage payments for the forbearance period
• Refrain from foreclosing the mortgage contract

Additionally, the mortgagee may demand an incentive for the missed payments. This is an additional payment and is paid separately from the traditional mortgage payments.

Using this agreement does not rescind the loan contract; it simply restructures the contract for the period remaining after the forbearance period. The other reliefs a borrower may seek have been discussed hereafter.

General Terms And Requirements

The Mortgage Forbearance Agreement varies with every mortgagee and mortgagor. The other determinants that impact the agreement are the loan term and the actual situation of the mortgagor.

This agreement is negotiable and should ideally accommodate the preferences of both the mortgagor and the mortgagee. Generally, the contract should be made on the following factors:

• Forbearance period length
• The procedure of repayments for missed payments
• Any late fees / additional incentives
• Any payments during the forbearance period 

The forbearance period length is decided jointly and depends upon the magnitude of the financial instability of the borrower. The size varies based on every contract.

After the commencement of the forbearance period, the mortgagor must continue paying the lender as before. The lender can choose the action for the missed payments during the break. The lender has the following choices:

1. The proportion of the amount to be paid in addition to the monthly payments
2. Receive the amount at the end of the mortgage term

In the first case, when the lender chooses to proportion the amount, the missed payments are divided by the number of months remaining in the contract. The resulting figure is added to the payments every month.

In the second case, the lender receives the missed payments and the final price at the last mortgage payment. Lastly, the lender can modify the loan structure based on their preferences.

The primary concern a Forbearance Agreement addresses is the mortgagor's financial hardship. It is required that a mortgagor must show proof of this hardship. This could be a termination letter in case of short-term unemployment.

Moreover, forbearances are reported to the credit agencies such as banks and financial institutions. This could impact the credit score of the mortgagor.  

Advantages of a Mortgage Forbearance Agreement

A borrower may approach their lender with a forbearance request if they firmly regard their repayment ability to be hindered. Utilizing such an agreement provides borrowers with the time they need to get back on their feet.

The option to use this agreement depends upon the borrower and their conditions. Understanding the implications of forbearance on the loan agreement is recommended. In light of this, the benefits of a forbearance agreement are listed below.

1. A Better Alternative To A Foreclosure

From the lens of a mortgagor, it is preferred to settle for a forbearance compared to a foreclosure. The mortgage agreement stands canceled in foreclosure, and the property is returned to the mortgagee.

A foreclosure is used chiefly as a longer-term solution to loan defaults. It is the last resort and should only be used when the mortgagor cannot repay the loan.

2. The Property Is Not Confiscated

In a foreclosure, the house is transferred back to the mortgagee. Alternatively, the mortgagor may retain the property during the break period in forbearance. This provides a sense of security in uncertain times, especially if the mortgagor is going through financial difficulties.

3. Provides Extra Time To Be Financially Sound

The forbearance period provides a temporary suspension of payments. 

4. Lower Impact On Credit Score

Although the mortgagor's credit score is negatively impacted when the mortgage is foreclosed, executing a forbearance agreement has a significantly lower impact on an individual’s credit than a foreclosure does.

This creates an incentive to select a forbearance as the mortgagor could resort to undertaking additional loans in the future if necessary.

Disadvantages of a Mortgage Forbearance Agreement

Now let us move on to some of the demerits to a Mortgage Forbearance Agreement.

1. Extended Mortgage Term

A Mortgage Forbearance Agreement grants the mortgagor a grace period to become financially sound. This three or six months grace period adds to the entire loan term.

For example, say an investor with a 5-year mortgage encounters some financial difficulty in the second year and cannot pay their dues. The debtor approaches the mortgagee to provide a forbearance period of 6 months. The total mortgage period extends to 5 years and six months.

Additionally, although the payments stand temporarily paused, the loan interest accumulates. This increases the interest payable throughout the loan because the term is extended.

In the scenario above, instead of the interest being accrued over five years, it will be accrued for an additional six months.

2. Only Short-Term Problems Are Addressed

A forbearance period is only a temporary solution for short-term liquidity problems. This aid is ideally used when the mortgagor has faced sudden financial distress, such as a pandemic-induced economic downturn. 

The parties can agree to restructure the existing payment schedule to incorporate the missed payments or pay the dues after the current payment schedule, i.e., at the end of the term. 

Mortgage Forbearance Example – The CARES Act

Families worldwide suffered hardships due to the COVID-19 pandemic, which struck rather unprecedentedly—companies engaged in rampant layoffs and dismissals to cut costs, losing a valuable revenue stream for employees.

As the magnitude of pending mortgage payments increased, the government introduced a scheme known as the CARES Act that provided aid for individuals unable to repay their debt obligations as the pandemic impacted them.

The Coronavirus Aid, Relief, And Economic Security (CARES) Act was established on March 27th, 2020. It was introduced to assist those in need in response to the pandemic-induced economic crisis.

The CARES Act offered federal-backed home loans to attain forbearance agreements. To be eligible two criteria had to be met:

1. The pandemic must impact the individual
2. The loan must be federally backed 

Unlike other forbearance agreements, the mortgagor must not submit hardship proof. This eased the procedure of attaining a forbearance, especially during times of sheer uncertainty.

Forbearance periods for government-backed mortgages are more extended than for private mortgages.

Typically a forbearance period lasts for three to six months and could be extended up to twelve months. The CARES Act, however, allows the forbearance period to be extended up to 18 months. Three months are offered initially, which may be extended upon request.

Now the CARES Act is no longer in effect. Approximately 16% of mortgage loan investors have used a forbearance agreement since the pandemic. Additionally, the forbearance agreement was only used for three months by those who utilized it. 

Other Relief Options

Before applying for a forbearance, the mortgagor must gain the prerequisite knowledge of what the agreement shall entail and the mannerism as to how their respective financial obligations may be affected and similar consequent reverberations.

The mortgagor may do so by availing advice from a legal advisor regarding the implications of a Mortgage Forbearance Agreement. The mortgagor must also be able to provide financial records that imply a future difficulty in servicing the mortgage.

The mortgagor could also, on their end, look out for schemes that assist in repaying mortgages. The Homeowners Association Fund is a government scheme enforced under the American Rescue Plan Act that helps citizens facing financial difficulties in mortgage payments.

Before taking any action, the mortgagor must also discuss with the mortgagee by stating their case using the financial records and any projections. It is up to the lender to decide on the type of relief they would exert upon the mortgage.

The other options available include a loan foreclosure, loan modification, or a short sale.

1. Loan Foreclosure

When a mortgage is foreclosed, the mortgagor must surrender the property to the mortgagee, who then resells it to the open market. The property is viewed as collateral, so the collateral is demanded when the mortgage contract is canceled.

The legal process is tedious and unavoidable. The mortgagee may recoup the remaining mortgage amount the mortgagor owes by selling the property. 

2. Loan Modification

In a loan modification, the mortgagor and mortgagee are still bound by the mortgage. However, the loan terms stand modified. It is typical for a mortgagor and mortgagee to agree on interest rates, principal payments, and payment schedules.

Through a loan modification, the mortgagee can receive the total mortgage amount by modifying the terms based on the mortgagor's preference and financial situation.

3. Short Sale

In a short sale, the mortgagor shall attempt to sell the property at an amount lower than the mortgage liability. All proceeds must be transferred to the mortgagee during this process.

If the mortgagor can sell the property at a lesser value, the mortgagee shall ideally forgo the difference. Alternatively, they may also demand the mortgagor pay the difference; it is, however, a rarity.

The mortgagor may pocket the excess proceeds if the property can be sold for a higher price. Such a scenario may arise when the market value of the property appreciates.

Researched and authored by Astrid Dsouza | LinkedIn

Reviewed and Edited by Shahrukh Azim Butt | LinkedIn 

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