• A workout agreement between a lender and a borrower replaces the loan’s original terms with one more beneficial for both parties.
• Lenders usually do this by granting a loan modification or forbearance.
• Loan modification changes the loan’s terms permanently, while forbearance pauses payments for a time.
• Forbearance has some downsides, including paying missed payments in one lump sum after it ends.

A workout agreement between a lender and a borrower replaces the loan’s original terms[1] with one more beneficial for both parties.

In a mortgage, a workout option is a way to restructure the debt to avoid foreclosure[2]. Workout agreements, whether a modification or a forbearance agreement, are meant to help get the mortgage back on track while reducing the impact of lender liability claims.

For a cash-strapped borrower, a loan workout provides some relief to recover financially without seeing a credit score decrease[3]. Meanwhile, the lender offers a chance to review the mortgage, restructure loan payments, and eventually collect everything owed without absorbing major losses.

Not all lenders agree to a workout agreement, and any real estate workout is handled case-by-case. To start the process, lenders are advised to enter a pre-negotiation agreement (PNA) which facilitates discussion without creating binding terms until both the borrower and lender settle on a contract.

The two common types of workout options are loan modification and forbearance. The latter tends to be more popular.

Loan Modification

A loan modification agreement permanently changes the original loan’s terms and security documents. The goal is to make the mortgage payments more manageable to prevent future delinquencies.

To achieve this, the borrower typically asks the lender for a lower interest rate[4]. The lender or loan servicer[5] might agree to this in exchange for pushing back the maturity date of the mortgage[6].

Regardless of how both parties negotiate to get what they want, modifying the loan is only an option when the borrower has already missed payments (or is at serious risk of falling behind). In addition, the mortgage lender will typically demand proof that the borrower is genuinely struggling before considering the request.

Loan modification does not affect the borrower’s credit score, but credit bureaus will usually notice the late payments leading up to or during the modification.

Forbearance

Forbearance does not change the loan terms but provides temporary relief from mortgage payments. This pauses payments over a certain period without the borrower becoming less creditworthy.

The CARES Act[7] is an excellent example of forbearance. Under it, government-backed and conforming home loan borrowers[8] may ask for a respite from paying their mortgages for three to six months. This payment break could be extended to a total of 18 months.

President Trump signs the CARES Act (The White House from Washington, DC, Public domain)

During forbearance, foreclosing is out of the question. In addition, the borrower does not have to present any financial hardship evidence to qualify.

Since forbearance freezes the ability of the lender or servicer to collect payments and charge late fees, the original mortgage terms stay the same.

Forbearance is not without its disadvantages. Here are some instances forbearance can do more harm than good.

• Not everyone qualifies. Unless the authorities promote it on a large scale to help ease the effects of lingering economic problems, the lender or servicer decides which one deserves this privilege.
• The principal is unchanged. Forbearance keeps the mortgage principal balance from shrinking. The debt obligations remain the same until one begins repaying what is owed on the property.

• Slows down equity growth. Not paying the mortgage debt could prevent or slow home equity growth. The home loan could sink underwater if local property prices fell, making it highly disadvantageous to resell the house when the need arises.
• Incorrect reporting. Like a loan modification, forbearance cannot affect creditworthiness. However, it is prone to human error on the lender’s side. This results in an unintentional credit score deduction.

Lastly, this workout option can jeopardize one’s chances of refinancing the home loan and miss out on lower mortgage rates[11].

Being granted mortgage forbearance does not mean the loan is forgiven. Eventually, one way or another, the unpaid loan principal and interest during the forbearance period have to be repaid once it ends.

Reinstatement typically follows forbearance, which renders all missed payments immediately due. Usually, homeowners who need forbearance can’t save enough cash to make a lump-sum payment (which was why they needed forbearance in the first place).

In these cases, an owner may have two options: deferment and repayment.

Deferment

Deferment postpones the lump sum payment to the end of the mortgage’s term.

With this option, the borrower does not have to catch up on the missed payments immediately. The unpaid balance can be paid in installments, so there is no pressure to settle everything immediately after the home loan matures.

The forbearance amount will be due at closing if the house is sold or the mortgage is refinanced before the deferment period.

The drawback to deferment is that it naturally extends the life of debt. The deferment period follows the mortgage repayment period, essentially an extension of the home loan.

Repayment

This option allows the borrower to pay higher monthly mortgage payments to compensate for the ones missed during forbearance. This way, everything gets paid off over time.

A loan modification, which can result in a loan reduction, may be the solution if one does not have the budget for slightly larger monthly mortgage payments.

1. VanSomeren, L. (2021.) What Are Loan Terms? Forbes Advisor. Retrieved from https://www.forbes.com/advisor/loans/what-are-loan-terms/
2. USAGov. (2022.) Foreclosure. Retrieved from https://www.usa.gov/foreclosure
3. McGurran, B. (2021.) Why Did My Credit Score Drop? Experian. Retrieved from https://www.experian.com/blogs/ask-experian/why-did-my-credit-score-drop/
4. Alcantara, C. (2022.) Calculate how much more mortgages will cost as interest rates rise. The Washington Post. Retrieved from https://www.washingtonpost.com/business/interactive/2022/mortgage-interest-rates/
5. Bob Musinski, B. (2022.) Lender vs. Loan Servicer: What’s the Difference? U.S. News. Retrieved from https://money.usnews.com/loans/articles/why-did-another-company-start-managing-my-loan
6. Cockerham, R. (2019.) How to Extend Mortgage Terms. The Nest. Retrieved from https://budgeting.thenest.com/extend-mortgage-terms-3779.html
7. Consumer Financial Protection Bureau. (2020.) CARES Act Mortgage Forbearance: What You Need to Know. Retrieved from https://www.consumerfinance.gov/coronavirus/mortgage-and-housing-assistance/cares-act-mortgage-forbearance-what-you-need-know/
8. Loftsgordon, A. (2022.) What’s the Difference Between a Conventional, FHA, and VA Loan? Nolo. Retrieved from https://www.nolo.com/legal-encyclopedia/what-the-difference-between-conventional-fha-va-loan.html
9. Caginalp, R. (2022.) Mortgage relief: What to know about mortgage forbearance. Bankrate. Retrieved from https://www.bankrate.com/mortgages/everything-you-should-know-about-mortgage-forbearance/
10. TransUnion. (2021.) Mortgage Forbearance and Your Credit. Retrieved from https://www.transunion.com/blog/financial-hardship/mortgage-forbearance-and-your-credit
11. Aarons, J. (2020.) The Rebound: Pros and Cons of Mortgage Forbearance. ABC 10News San Diego. Retrieved from https://www.10news.com/news/local-news/san-diego-news/the-rebound-pros-and-cons-of-mortgage-forbearance