Navigating financial hardships can indeed be like walking a tightrope. But here’s the good news: understanding tools like forbearance can provide you a safety net. Forbearance acts like a pause button that allows you to momentarily stop or reduce certain debt payments until you get back on your feet. If you’re contemplating forbearance, consider speaking with a financial advisor about your options.
Understanding Forbearance
Forbearance enables a borrower to postpone or even reduce their loan payments when they’re facing financial challenges. Mortgages and student loans are common areas where forbearance is applied.
Forbearance isn’t forgiveness – it’s a strategic pause or temporary reduction in payments. It’s crucial to remember that the missed payments are not eliminated but rather postponed. Interest may still accrue, leading to a slightly larger balance to be repaid in the long run. However, this arrangement can prevent default and the resulting damage to credit scores.
It’s also important to differentiate forbearance from deferment. While both offer relief, interest doesn’t accrue for all loans in deferment, including subsidized federal student loans.
Mortgage Forbearance
Mortgage forbearance is a temporary agreement between a homeowner and their lender that allows the homeowner to pause or reduce their mortgage payments for a specific period. This option is typically extended during times of financial crisis, such as job loss, medical emergencies, or natural disasters.
During the Covid-19 pandemic, many homeowners found themselves in need of such assistance due to unexpected job losses and economic instability. Mortgage forbearance allowed homeowners to temporarily halt their payments, providing some breathing room.
Student Loan Forbearance
While mortgage forbearance extends temporary relief to homeowners, student loan forbearance does the same for former students. There are generally two types of student loan forbearance: discretionary and mandatory. Discretionary forbearance is typically up to the lender’s discretion and may be granted for various reasons, such as financial hardship or illness. On the other hand, mandatory forbearance is required by law under specific circumstances, like serving in a medical or dental internship or residency.
How Forbearance Impacts Your Account
Before entering forbearance, individuals should understand its implications fully. While it provides immediate relief, it’s essential to evaluate the long-term impact it can have on your finances.
Risks of Forbearance
Keep this risks in mind as you consider pursuing forbearance:
- Accrued interest: One of the key risks of forbearance is the accrual of interest during the period of reduced payments. While you may not be making your full mortgage or student loan payments, the interest on the loan continues to accumulate. This means that when the forbearance period ends, the unpaid interest is added to your principal balance, potentially leading to higher overall loan costs.
- Extended loan term: Forbearance doesn’t eliminate the obligation to repay your loan; it merely postpones payments. As a result, the term of your loan may be extended to accommodate the missed payments. This can significantly increase the time it takes to pay off your mortgage or student loan, potentially affecting your long-term financial plans.
- Credit implications: While forbearance itself doesn’t directly impact your credit score, it may appear on your credit report and can still have repercussions. Say, you’re late with your payments after a forbearance period – that’s going to negatively affect your credit score.
- Lender’s terms and conditions: It’s crucial to understand the terms of your forbearance agreement. Some agreements require a lump-sum payment at the end of the forbearance period, while others might offer a repayment plan to catch up on missed payments. Failing to comply with the terms could lead to foreclosure on home loans, not usually on student loans unless they’re collateralized, which is rare, or other consequences.
How to Apply for Forbearance
If you’re ready to apply for forbearance, here’s a closer look at the process:
- Contact your lender: If you’re facing financial difficulties, get in touch with your lender as soon as possible and before you miss a payment. They can explain the forbearance options available and guide you through the application process.
- Understand the terms: Each lender’s forbearance terms might vary. Understand the duration of the forbearance, whether it’s a suspension of payments or reduced payments, and how the missed payments will be repaid.
- Make a repayment plan: Work with your lender to establish a feasible repayment plan for the deferred amounts. This could include adding a portion of the missed payments to each future mortgage payment or adjusting the loan term.
What Happens After Forbearance Ends
When the forbearance period ends, borrowers usually have to repay the total postponed amount in a lump sum, in a series of additional payments or through a loan modification. The latter changes the terms of your loan and may make your monthly payment more manageable if you’re still struggling financially. You also may have the opportunity to extend your forbearance period if you’re still facing financial hardship.
Bottom Line
Forbearance can be a valuable tool for homeowners and people with student loans facing financial hardships. It offers a temporary respite during challenging times and can help you avoid immediate foreclosure or default. However, it’s vital to approach forbearance with a clear understanding of its consequences and a solid plan for repaying the loan after the temporary pause or payment reduction.
Debt Management Tips
- A financial planner can help you manage your debt and determine whether forbearance is a viable option. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Getting out of debt takes planning and perseverance. The debt snowball method calls for making minimum payments on all your debts while funneling extra money to the one with the highest interest rate. Alternatively, you may want to start by knocking out your smallest debts first – regardless of their interest rates – which can provide a psychological boost and help you generate momentum. Here’s a step-by-step guide to becoming debt free.
Photo credit: ©iStock.com/designer491, ©iStock.com/Tippapatt, ©iStock.com/kohei_hara