Forbearance: Is It A Good Idea?
Don’t do it!! Don’t you dare do it!!” Some strong advice from a passionate financial expert. Barry Habib was discussing forbearance plans in a recent podcast geared toward real estate investors. I have followed Barry for a while, mostly because of his focus on lending and his extreme savvy when it comes to economics. Typically, his advice is aimed at lenders, but this was very firm advice to real estate investors. There is a lot of hype out there about forbearance agreements, and rightfully so, as they can be extremely attractive and super helpful. Some of the rumors make these sound too good to be true, so I went looking for the truth. Can ordinary investors, like you and me, take advantage of this already if we don’t financially need it? The short answer is yes, but it comes at a price.
A forbearance agreement in its simplest form is an agreement between a lender, or loan servicer, and a borrower to not make the scheduled payments as originally agreed. If we focus on real estate loans, a forbearance agreement would prevent a loan servicer from starting a foreclosure on the character during the term of the agreement. Up until now, if you entered into a forbearance agreement on a home loan, you would stop a foreclosure, but it would nevertheless be reported as missed payments on your credit.
So why all the hype? The CARES Act has made some dynamic changes around these agreements. First, loan servicers for government backed or government owned loans are required to issue forbearance agreements for anyone who wants them. Yes, that is right, anyone who wants them. In the past, these agreements were hard to get, and a borrower would need to qualify and document financial hardship. Now if the loan is owned or backed by the government, every borrower will get 180 days with no questions asked which they can extend for a second 180 period if they choose. There are no fees or penalties to take advantage of this. One important point that was a topic of confusion is that this money is not free. There may be no fees, but anyone entering into this agreement will need to make up the missed payments. An early misunderstanding was that borrowers would need to come up with one lump sum payment for all the payments that were not made. That would have produced enormous foreclosures, which produced fear. It was because of this belief that many investors believed we would see another housing bubble burst. The truth is that each loan servicer will have the flexibly to come up with a repayment plan for each individual borrower. Although it is true that a lump sum payment is one of the five repayment options, it is not necessarily required. It is far more likely that there will be an affordable plan put in place which should prevent a enormous increase in foreclosures. Other than the lump sum option, here are the four repayment options that a loan servicer could implement with each borrower.
- Borrowers allowed to repay past due amount within 12 months after forbearance ends.
- Extend the term of the mortgage by the exact number of months in forbearance.
- Add past due amounts into loan balance and extend the term of the loan by the number of months necessary to make the monthly payment the same as the past payment.
- Add past due amounts into loan balance and extend term of loan for 40 years (480 months).
Basically, the borrower will be able to extend the loan term to make up these payments. These are specific to Fannie Mae and Freddie Mac. Other lenders or servicer for other types of loans could have slightly different options.
So, if you automatically qualify and there are no fees, why would you not do this? Here are three deadly pitfalls, which is why I believe you should avoid doing forbearance agreements on your mortgages if you are able:
- Depending on your repayment option, you could accrue interest on these payments. Since most of your payment is likely interest, you will be accruing interest on interest which gets very expensive in the long run. It will limit your borrowing strength. Let me explain, although it is true that the CARES Act will prevent loan servicers from reporting missed payments, the fact that you entered into this agreement will report. Not reporting the missed payment will keep your credit scores intact, but any lender looking at the payment history will see the forbearance agreement. I could not find clarity on this, but most experts believe that it will truly say, “forbearance agreement” right on the credit report for each agreement you go into into. I know this is true because three of the largest lenders in this country have already stated they will be creating underwriting guidelines around COVID caused forbearance agreements and will not extend credit for two to four years post forbearance agreement. That method by simply trying to work the system and not making payments, you could be out of the game for two to four years!! I am not sure that we will, but if this pandemic creates buying opportunities, it will certainly be before you are able to borrow again.
- By not making payments on loans, it hurts the overall housing market. Taking the ethics out of this decision, the more people that take advantage of the forbearance agreement, the less liquidity lenders will have, meaning the tougher the guidelines will get. This, of course, reduces need for housing.
The interesting thing about all this is loan servicers do not understand the ramifications for putting you in a forbearance agreement. It is the lender that owns the loan and lenders that will originate new loans that understand this, but unfortunately that is not who you are talking to when you call your mortgage company to ask about this. I want to be very clear that forbearance is a fantastic option if you need it. It helps people in need and will help continue home values as we work by the COVID crises. I am only recommending not doing it if you can provide to continue the payments. I also want to mention that these rules and privileges are for government loans only. Third party lenders like edges, credit unions, and private lenders are not unprotected to these guidelines.