Approximately a year ago, the first round of government stimulus checks was about to hit millions of Americans’ bank accounts. Increased unemployment benefits were approved and lenders and creditors provided deferments on mortgage and credit card payments to hold off a potentially massive wave of evictions and defaults. As a result of the COVID-19 pandemic, extraordinary measures were taken to help keep millions of Americans who had lost jobs, incomes, and businesses afloat.
But what happens when all of those lifelines begin to expire?
It’s understandable that millions of people took advantage of deferment or forbearance to get through the last year of extreme economic uncertainty. However, many of these programs which were designed to temporarily ease financial pressure will soon be gone. If you did this or are still thinking of doing so, make sure you’re aware of the potential pitfalls.
Understanding Forbearance and Deferment
Generally speaking, forbearance is an option for managing debt that is offered by lenders in response to a sudden, unexpected financial disruption. The pandemic is a great example of this. It can be offered at other times, such as after a natural disaster, for example. An important consideration to keep in mind is that forbearance does not wipe out, eliminate, or forgive a debt that is owed; it’s meant only as a form of temporary financial relief.
As far as credit cards go, forbearance can involve receiving credit line extensions, deferring payments temporarily, reducing interest rates, or eliminating fees. Any kind of forbearance that is negotiated will be determined by your own personal circumstances and finances, as well as the credit card issuer’s policy.
If you've received or are considering mortgage forbearance, your options will vary depending on if your mortgage is privately owned or government-backed. It’s important to talk with your lender to determine which type you have, as terms will be different for each.
Forbearance and deferment are terms that are often used interchangeably, but they are not exactly the same thing. If you receive deferment from your credit card issuer, for example, the interest on your balance will still be compounding. If it were put into forbearance and fees that are tied to the balance could be suspended temporarily (depending on the issuer), but even in this case, interest is still likely to accrue.
There can also be a difference between the two alternatives as it relates to the length of time payment is suspended. If you receive a deferment on your credit cards, it’s usually for a short period, and payment in full is typically expected when the deferment ends. A forbearance can last longer – up to several months – but keep in mind that even if you receive a longer period of suspended payment, your compounding interest will still be adding up.
Problems with Forbearance
Of course, when faced with an unexpected financial crisis, temporarily relieving the burden of credit card payments may seem like a good idea, but there are some inherent problems with this approach. The most obvious is that the bills are still sitting there waiting for you when it ends. Another potential problem with this is that every credit card issuer will have their own specific conditions of a forbearance program, so some people could find themselves in a worse position after the temporary suspension of payments is over. For example, if a credit card issuer simply reduces monthly payments instead of pausing them completely, this would lower the monthly payment, but you’d end up paying more long-term because of added compounding interest.
Another point to keep in mind is that accrued interest can end up having a negative impact on your credit score. Even if you negotiate temporary relief with your card issuer and are able to pause payments, obtain lower payment terms, or remove late fees, the interest that is accruing on your balance can result in your credit utilization rate. And if that rises above 30%, then your credit score will suffer.
The Bottom Line
With millions of Americans losing jobs or having incomes reduced as a result of the COVID-19 pandemic in the last year, these programs offering temporary relief have become popular. But people should really put serious thought into the potential drawbacks of these types of programs because the short-term relief could end up costing them more money in the long term.