What is Forbearance?
Forbearance, which literally means 'holding back,' is a temporary suspension of loan payments agreed to by both lender and borrower as an alternative to defaulting on the loan (or foreclosure in the case of a mortgage). Lenders choose forebearance agreements in order to avoid the loss and costs of a loan default.
Forbearance Agreement: How it Works
There are many reasons why a borrower may need to establish a forbearance agreement. Borrowers may find themselves in unexpected and unfavorable financial situations during the life of a loan, such as becoming unemployed or temporarily disabled. Forbearances are very common among those unable to pay back their student loans (which we talk about in the sections below).
Typically, a forbearance agreement is arranged between the borrower and lender. A lender's willingness to make such an agreement depends on the probability that the borrower will be able to resume regular monthly loan payments once the forbearance ends.
In some situations, the lender may approve a simple reduction in the borrower's payment and not a full pause on repayment. This depends on the borrower's circumstances and the lender's faith in the borrower's ability to eventually resume regular payments.
In other situations, the lender and borrower may come to an agreement where only the principal or the interest is paid until the period of need ends. Again, this depends on the borrower's situation and the lender's faith in the borrower's ability to eventually resume regular payments.
During the period of forbearance, the borrower may be responsible for any additional interest that accrues.
Student Loan Deferment vs Forbearance
For federally-insured student loans, lenders are required to grant forbearance under certain circumstances, for example, if the borrower is employed in a medical residency or as an Americorps volunteer.
Alternatively, student loan creditors may grant a deferment, which is also a suspension of payments but with the government responsible for any interest that accrues. The difference between forbearance and deferment is in the responsibility for the interest payments.
Is a Forbearance Bad for Your Credit?
Forbearance agreements may be noted in a credit report, but should not affect the borrower's credit score unless the terms of the agreement are not fulfilled. It's important that the borrower resume making their payments on time as agreed upon after the forbearance agreement ends.
[After forbearance: 7 Simple Ways to Pay Off Any Size Student Loan Debt]