All You Need to Know About Mortgage Forbearance, and How to Avoid It

Should you look into mortgage forbearance?

If you’ve been struggling with your mortgage payments for pandemic (or other reasons), the answer is a (qualified) yes.

You’re not alone.

A recent study by Deeds.com found that 6.6 million American households have fallen behind on their mortgage payments.  Another analysis that looked at data from the Federal Reserve Bank of New York determined that the number of delinquent mortgage balances has risen steadily over the last three years. As of September 2024, the Mortgage Bankers Association estimated that 170,000 homeowners were in forbearance.

Forbearance is an option for homeowners facing financial hardship, who are trying to avoid foreclosure.

You may have recently gone through a life event which changed the game for you. Let’s explore how mortgage forbearance works and what other alternatives may be available.

What is mortgage forbearance?

Forbearance is a temporary, penalty-free break or reduction in your mortgage payments during a rough financial patch.

Note that just because your lender or mortgage servicer grants you forbearance doesn’t mean they have forgiven those payments. You must still repay any missed payments once the forbearance period ends.

Alternatives to mortgage forbearance

Forbearance could impact your ability to refinance or secure a loan for a new home. That’s why you may want to consider other options first and view forbearance as a last resort.

Loan modification

A loan modification is exactly what it sounds like: a change to the original terms of your mortgage. You may ask your lender to:

• Extend the loan term
• Reduce the interest rate
• Change the rate from an adjustable to a fixed rate
• A combination of the above

Note that lenders are under no obligation to agree to a modification. A loan modification may also negatively impact your credit score.

Cash-out refinance

Refinance replaces your current mortgage with one that has better terms, such as a lower interest rate or monthly payments, or a larger loan amount. You can use the difference to pay off debt or to meet other financial needs. To qualify for a cash-out refinance, you typically need:

• A credit score of 620 or higher
• A debt-to-income ratio (DTI) of 50% or lower
• Considerable home equity

Home equity loan or home equity line of credit

Both home equity loans (HELs) and home equity lines of credit (HELOCs) allow you to borrow against the equity you’ve built up in your home, with the property serving as collateral. The difference is that with a HEL, you get a lump sum upfront, whereas a HELOC gives you access to a rolling line of credit, similar to a credit card.

Repaying a HEL starts right away in the form of fixed monthly payments.

HELOCs are more flexible. There is an initial draw period, usually about 10 years, during which you can borrow funds when and as you need them (within your credit limit). During the draw period, the lender may only require you to make interest payments. Then comes the repayment period, usually 20 years, during which you repay the amount you’ve borrowed in monthly payments.

To qualify for a home equity loan or a HELOC, you will typically need:

• At least 15-20% home equity
• A credit score in the mid-600s or higher
• DTI of 43% or lower

Home equity agreement (HEA)

If you’re unemployed, furloughed or have a less-than-ideal credit score, you likely will have a hard time qualifying for debt-based products like a cash-out refinance, HEL or HELOC. In that case, you may want to consider an equity-based product such as a home equity agreement instead.

Because HEAs aren’t loans, there are fewer income and credit score requirements. You can typically qualify with a minimum credit score of 500 and a maximum loan-to-value (LTV) ratio of 80%. There are also no monthly payments or interest.

Here’s how it works: You get a lump sum upfront, typically up to 80% of your home equity, and the HEA provider receives a share of the proceeds when you sell the property, usually in 10 years. In effect, you are selling a portion of the equity to the HEA provider in exchange for cash.

In the meantime, you get to live in your home and enjoy all the benefits of homeownership as normal. And if you don’t want to sell your home at the end of the term, you can buy the provider out.

The bottom line: Mortgage forbearance is a serious step

Before requesting forbearance, explore all other options with your mortgage servicer and an independent financial adviser. Make sure to also look into non-debt-based products such as a HEA. Equity can often solve problems debt-based products can’t.

Find out how much you could qualify for through a home equity agreement here.