19 November 2020 / Larry R. Rothenberg

Some Things Servicers Should Inform Borrowers About Forbearance, or Full or Partial Loan Forgiveness

Topics: Real Estate

The Mortgage Bankers Association has reported that as of November 8th, 2.7 million homeowners are in active forbearance plans.  Although the rate of new forbearance requests has declined for the 11th straight week, as forbearance periods expire, borrowers that are still experiencing financial hardship are likely to request an extension or other solutions such as a short sale or a deed in lieu of foreclosure.  Here are some things servicers can do to increase the probability of a full recovery and reduce the probability of a borrower making a claim of wrongdoing by the servicer.
The federal CARES Act, enacted in March 2020, requires servicers of federally-backed residential mortgages to provide forbearance for up to two consecutive 180-day periods, upon receiving a request for forbearance from a borrower and the borrower’s attestation as to financial hardship caused by the COVID–19 emergency. The borrower need only submit a request and affirm they are experiencing financial hardship during the COVID-19 emergency. If the borrower under a federally-backed residential mortgage does so, the CARES Act mandates that forbearance “shall” be granted.
Servicers granting forbearance should ensure the borrower understands that a forbearance plan does not forgive any mortgage payments. Rather, it merely delays them to be paid when the borrower comes out of financial trouble. After the forbearance period, the borrower must pay both the regular monthly mortgage payments and additional payments either monthly or a balloon at a designated time to cover the payments accrued during the forbearance period. If the borrower doesn’t budget accordingly, the borrower may fall back into financial difficulties.

At least once during the forbearance period servicers should inform the borrower (in writing) of the following: 
  • The outstanding obligation to repay; 
  • The amount of the unpaid principal balance and any unpaid interest that has accrued on the loan since the last notice provided to the borrower;
  • The fact that interest will accrue on the loan for the full term of the forbearance; 
  • The amount of interest that will be capitalized, as of the date of the notice, and the date capitalization will occur; 
  • The option of the borrower to pay the interest that has accrued before the interest is capitalized; and 
  • The borrower's option to discontinue the forbearance at any time. 
Full or Partial Loan Forgiveness
Borrowers’ requests for other types of solutions, such as short sales or deeds in lieu, often include requests for full or partial loan forgiveness. If granted, upon completion of the transaction the servicer will issue a 1099C form to report the full or partial loan forgiveness, to the Internal Revenue Service.  The IRS generally deems as taxable income the cancellation of debt for which the borrower is liable, with certain exceptions such as provided in IRS Code Section 108 (a)(1)(a) if the cancelled debt has been discharged in bankruptcy, or in Section 108(a)(1)(B) if the borrower qualifies as insolvent.  

Although servicers should never make representations to borrowers regarding tax consequences, servicers should advise the borrower to consult the borrower’s own tax professional. 

In addition, full or partial forgiveness of debt may have a negative impact on the borrower’s credit record. 

Therefore, if the servicer agrees to full or partial loan forgiveness, the servicer should inform the borrower and include in their loss mitigation agreement, express provisions that the servicer will report the debt forgiveness to the IRS on Form 1099C, and that the servicer will follow standard industry practice in reporting to the major credit reporting agencies.  

Doing so can help ensure that the borrower will make a fully-informed decision, and help reduce the probability of a borrower claiming wrongdoing by the servicer.

This blog is not a solicitation for business and it is not intended to constitute legal advice on specific matters, create an attorney-client relationship or be legally binding in any way.

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Larry R. Rothenberg


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