Forbearance is a term used to describe a pause in required payments on a loan. This is common with student loans and mortgages. Lenders will grant a forbearance when borrowers lose access to income and cannot continue to make payments for some time. The forbearance halts required monthly payments for a period of time, usually no longer than a year, and then allows payment requirements to resume, counting the missed payments back into the total amount. This has effects on credit ratings depending the borrower's situation.
Forbearance Timing
The timing of the forbearance is important. A forbearance cannot cancel out loan payments that have already come due but have not been made. A borrower may qualify for a forbearance, but if they still have previous payments they have not made, these will be recorded as late and have a negative effect on the credit rating and continue to lower credit until they are fully paid off.
Direct Effect
A forbearance has little direct effect on a credit rating. This is why it is a popular choice for those who are struggling to make their monthly payments. No debt is recorded as late as long as all payments are up to date, and when the forbearance ends the borrowers can continue to build up credit.
Long-Term Effects
In the long term, a forbearance can make it more difficult to pay off the loan. Since the missed payments are added back into the loan amount, a forbearance raises the monthly payments required when they resume. As a result, the borrower may find it more difficult to pay off the loan and may have a greater chance of missing future payments, leading to lower credit ratings.
Alternative Actions
The alternative to forbearance is often a defaulted loan or late payments. These options have severely negative effects on credit and can make it very difficult to get a new loan. In this way, by helping borrowers avoid defaulting, forbearances (and other options like deferred payments) can have a highly beneficial, if passive, effect on credit ratings.
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