Loan Forbearance Agreement. Should You Sign One?

The world is about to embark upon the largest economic experiment in history. They have no choice really. In a Formula 1 race, the yellow flag comes out when there is a problem on the track and the race is temporarily suspended. The cars continue to circle around the track. The speed is reduced to a safe speed and its impossible to make forward progress. Yes, you’re still burning fuel, but the race is temporarily suspended.

Never before have governments tried to put swaths of their economies in an induced coma and awaken them gradually. There is no yellow flag built into our economic system. One of the biggest impediments to the yellow flag is debt. Debt service appears as a fixed cost regardless of the level of business underway. But of course the debt was procured with an assumed underlying level of business. There was never an assumption that business would stop, or in fact that loan payments could stop on a large scale.

On today’s show we’re talking about whether you should take advantage of the loan payment holiday that some lenders may offer.

The fact is, we don’t know the scope of the Covid-19 problem. We don’t know if this period of social isolation is going to last weeks, months, or years. We already know that many countries have been shut down for

If a lender offers you a payment holiday, or perhaps an interest holiday, you will sign a document called a forbearance agreement.

A mortgage forbearance agreement is an agreement made between a mortgage lender and delinquent borrower in which the lender agrees not to exercise its legal right to foreclose on a mortgage and the borrower agrees to a plan that will bring the loan current.

The thing to remember is that we are only a few weeks into a pandemic of unknown scope and duration. If you approach your lender now, the banks only have the tools that have been made available to them by the government and the central bank. Much of the economic stimulus was based on the assumption of a short term situation. Let’s put this in perspective. The US is spending $2T in stimulus, which is a huge amount of money.

A report in the Wall Street Journal today suggests that we are expecting to see a contraction of about 30% in GDP in the second quarter. The stimulus would cut that reduction in half, or about a 17% reduction in GDP. It’s highly likely that additional stimulus programs will be forthcoming as the breadth of the damage becomes visible.

While I haven’t seen the language of the forbearance agreements directly, what I’m hearing from investors I’ve spoken with is that the terms of the forbearance agreements are pretty draconian.

As more stimulus becomes available in the coming weeks, I expect that the terms of the forbearance agreements will become more generous. If you have the financial strength to survive a few more weeks, you may get a more generous relief package and a more lenient forbearance agreement, either in terms of terms or duration. This is a fast moving situation.

There are other programs that may apply to your business that you might consider first. For example, there are forgivable loans that are available in the US through the Small Business Administration to assist with payroll.

In Canada, there are programs available through the Business Development Bank of Canada.

In the UK, Employers can claim for 80% of furloughed employees’ (employees on a leave of absence) usual monthly wage costs, up to £2,500 a month.

My recommendation is to look at some of those other programs first. A lender is likely to sign a single forbearance agreement, but not two or three forbearance agreements if this economic downturn gets extended beyond the initial number of weeks that governments around the world have been projecting.