If you're struggling to pay your mortgage, your lender may offer you forbearance. Think twice before you take the deal.
Forbearance is a lender-approved reduction or elimination of your payments for a short time, usually a few months. Until recently, lenders made forbearance offers voluntarily, often in response to a temporary financial setback, such as a layoff, and the deals typically required borrowers to catch up on the missed or reduced payments within a year.
Under the Obama administration's recently announced expansion of the Home Affordable Modification Plan, or HAMP, lenders in the program will be required to offer forbearance to unemployed homeowners for at least three months and in some cases up to six months. Payments must be reduced to 31% of borrowers' incomes.
- Homeowners must meet HAMP eligibility requirements, which include owner occupancy (no rentals or investment property), a loan balance below $729,750 and an origination date before Jan. 1, 2009.
- Homeowners must ask for forbearance.
- Homeowners can't be more than three months behind with their payments. (They can be current and request forbearance; they just can't be more than 90 days overdue.)
- Homeowners must provide proof they're receiving unemployment benefits.
If a homeowner finds a job within the forbearance period and her regular payments would exceed 31%, she must be considered for a permanent loan modification.
Most such modifications so far have involved reducing the loan's interest rate and/or extending the loan term up to 40 years, but the Obama administration is now offering incentives to encourage lenders to forgive portions of some borrowers' loans.
If borrowers who got forbearance don't qualify for a modification that includes a reduction of their principal, though, they're expected to pay back the difference between their reduced payments and their regular payments, said Brian Sullivan, a spokesman for the U.S. Department of Housing and Urban Development.
"These mortgage reductions are not forgiven," Sullivan said. "They are repaid unless the borrower qualifies for a principal write-down."
If borrowers don't find employment by the end of their forbearance, they may be considered for foreclosure alternatives such as a short sale (in which the lender accepts the sale proceeds as full payment for the loan) or deed in lieu of foreclosure (which allows a homeowner to hand back the house keys in order to avoid full-blown foreclosure).
If your situation isn't too dire, it's possible that forbearance -- either the kind lenders offer voluntarily or the kind required under HAMP -- could get you back on track financially. But forbearance might not work, and it could leave you even worse off.
Here's what you need to consider:
Forbearance typically hurts your credit. When you don't pay lenders what you originally owed them, they typically take their revenge by reporting you to the credit bureaus as making late or partial payments. That can trash your credit scores.
That's certainly been true for the forbearance that lenders have been offering voluntarily, as well as for loan modifications, and it's likely to be true under HAMP forbearance as well, said real-estate expert Ilyce Glink, the author of the book "Buy, Close, Move In!"
When HAMP was first announced, "we were told loan modifications wouldn't hurt people's credit," Glink said. That turned out not to be true, she said, and signing up for loan modifications "destroyed a million people's credit."
How much damage you might suffer depends on how high your scores were to start with, with higher scores taking bigger hits. That's why you shouldn't seek forbearance if you have other ways of paying your mortgage, such as tapping savings.
But you also should be realistic if you're in trouble, because every option that would save your wallet some pain is likely to inflict some damage on your credit history and credit scores, Glink said. Forbearance would certainly have less of an impact than losing your home to foreclosure.
Continued: It may not be enough