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 even 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 property 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 still 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 created massive foreclosures, which created 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 massive increase in foreclosures. Other than the lump sum option, here are the four repayment options that a loan servicer could implement with each borrower.
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:
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 maintain home values as we work through the COVID crises. I am only recommending not doing it if you can afford to continue the payments. I also want to mention that these rules and privileges are for government loans only. Third party lenders like banks, credit unions, and private lenders are not subject to these guidelines.