How will they affect borrowers in the long run?

When Congress passed section 4021 of the CARES Act in response to the effects of COVID-19, the intent was to help borrowers who were having problems making their mortgage payments. Little did Congress realize they were potentially setting up borrowers for trouble in the future when it comes to credit worthiness.

The “Gotcha”
Section 4021 of the CARES Act contained a regulation that loan servicers “shall report the credit obligation or account for those participating in forbearance as current.”  In other words, those participating in a forbearance program should not see their credit scores drop.

However, there is a loophole that allows lenders to discover whether a borrower is actually making payments. It is the “comments” section of a credit report. The CARES Act does not mention the comments section of credit reports, and that’s where forbearance notations are going. What borrowers are not being told is that any reference in a credit report to forbearance can be a Scarlet Letter for an applicant seeking a new mortgage, according to Kathleen Howley in an article she wrote in early May 2020.

According to Mark Hanf, president of Pacific Private Money, within a week of Howley’s article, his company received a loan request from a homebuyer who was denied credit from a major bank for this very situation. Although the bank sees the existing mortgage as “current,” the forbearance has let the world know via the comment section that this borrower has requested a deferment. The major bank involved would most likely not deny the loan on its face due to the deferment, as this would violate the law; however, banks are notorious for coming up with myriad reasons for denying a loan and still staying within the guidelines set out for them.

Conventional lenders desire to have plain vanilla borrowers who pay back loans in a timely manner. When a borrower changes loan terms by requesting principal forgiveness or other aspects of the loan, the lenders generally do not usually extend credit again to these borrowers and can negatively affect the borrower’s ability to borrow again from unrelated lenders.

Such was the case during the Great Recession when some borrowers took advantage of the economic climate by asking their lender to reduce the principal of their loan [total forgiveness rather than just a deferment]. The borrowers may have gotten a reprieve, but the long-term effects may have been more drastic. Similarly to when a borrower files bankruptcy, the borrower may get out of paying creditors, but their ability to borrow in the future is usually severely hampered.

In one case, back in 2009, during the heart of the Great Recession, one banker tells a story of how a wealthy borrower first asked for a principal loan reduction of $500,000 because the value of his collateralized real estate had decreased. His request was granted. But, when this borrower was faced with the prospect of having the reduction reported on his credit report or the fact that he would have to inform any new lender that he requested a principal reduction [as this question is usually on bank applications], he voluntarily requested that the $500,000 abatement be reinstated. He decided his ability to borrow in the future was worth more than the $500,000 principal reduction.

Is It Worth It?
Borrowers will have to decide whether requesting deferments is worth the risk of potential future lending restrictions. Whoever said “there’s no free lunch” must have been talking about these very situations.

From a private lender perspective, borrowers seeking credit likely will not see a change in approval based on having a past forbearance listed in their credit comments. Most private lenders—if they evaluate credit at all—will rely on the loan to value of the collateral. Like a one-time medical issue that racks up high hospital bills, private lenders have more freedom to evaluate the specific situation involved.

As in other areas, banks and credit unions’ additional strictures usually create opportunity for private lenders to fill the gap. When borrowers cannot find credit via traditional means, savvy private lenders who know about the potential issues and can get in front of them at the right time will likely find these borrowers to be perfectly acceptable.