Many people take out loans for all sorts of reasons, with loan terms ranging from short to long. Over the course of a long-term loan, a borrower’s ability to repay can be affected by a wide range of circumstances, which may leave them unable to continue making loan repayments and can seriously damage their personal credit.

The pandemic, which has now lasted nearly two years, has significantly changed many people’s financial situations and may leave some unable to keep up with loan repayments. Today we will discuss how, when a borrower cannot repay a loan, the answer is not necessarily to “keep owing” or “keep stalling” — as a borrower, there are other options available.

Option One: Modify the Loan Agreement

The term of a loan agreement can range from a few months to 40 years. During this period, a borrower may run into financial difficulty due to various unforeseen circumstances such as job loss, business failure or health problems, making it difficult to repay the original loan. In this situation, the borrower can discuss alternative options with the lender before falling behind on repayments, and one such option is to modify the loan agreement.

Modifying the Loan Agreement

A modification to a loan agreement requires the consent of both parties, and can give the borrower more affordable repayment terms. If the cost of modification is lower than the cost of default, it is also beneficial for the lender.

Loan terms can be modified in the following ways:

– reducing the loan interest rate;

– converting the loan from a variable rate to a fixed rate;

– extending the loan term;

– changing the frequency of repayments; or

– reducing the loan principal (this is uncommon)

Modifying a loan agreement generally involves the following steps

– review the terms of the original loan documents to understand rights and obligations; these documents will also set out how the agreement can be modified

– identify the terms that can be modified

– contact the lender to discuss the situation — note that the request to modify the loan agreement must be made before falling behind on repayments

– sign an agreement to formally complete the modification of the loan agreement

The lender naturally cannot agree to modify the loan agreement without any reason or basis. They will generally require the borrower to provide the following supporting documents to assess the borrower’s financial position, for example:

a hardship statement letter

financial statements;

tax returns

a business plan

The lender will use these documents to understand the borrower’s financial difficulties and determine whether to approve the loan modification.

In short, the lender needs to be satisfied, or given assurance, that after modifying the loan agreement the borrower will be able to overcome their difficulties and repay the loan.

Option Two: Enter Into a Forbearance Agreement

Another option available to the lender and the borrower is to enter into a forbearance agreement. A forbearance agreement can provide that the lender allows the borrower to miss or reduce mortgage repayments for a specified period (the forbearance period). During this period, the lender will refrain from exercising the rights that arise from the borrower’s breach of the loan agreement.

In return, the lender will usually require the borrower to satisfy certain requirements, for example, putting a plan in place to resolve their financial issues, or expecting the borrower to resume full payments at the end of the forbearance period and make additional payments.

The main difference between a loan modification and a forbearance agreement is that the latter generally provides short-term assistance to borrowers experiencing brief financial difficulties. So for borrowers who may never be able to repay their existing loan, a loan modification is a solution that can resolve the problem permanently.

Option Three: Refinancing

Borrowers facing financial difficulties who may be unable to repay their debts should also understand the option of refinancing. Refinancing involves using a new and different loan to repay an existing loan. Refinancing typically involves the borrower obtaining a loan with a different interest rate and term. When current interest rates are lower than the rate on their existing loan, this can be an attractive option for borrowers.

In Conclusion

If a borrower finds themselves unable to continue repaying a loan, they must not try to resolve the situation by falling into arrears, because the end result of arrears is very likely to have many adverse effects on the borrower. Even if the loan is ultimately repaid in full, the impact on the borrower’s credit will last for a considerable period of time. While their credit is impaired, it will be very difficult for the borrower to obtain other forms of financing, making it hard to participate in new business ventures, acquire assets, and so on.

Whatever happens to the borrower, the first thing to do is to consult a professional and communicate promptly with the lender to find an appropriate way to resolve the loan repayment issue without damaging their credit. Modifying the loan agreement, refinancing, short-term forbearance or a loan extension may all help to resolve the borrower’s difficult situation.

In short, as a borrower it is important to understand the various solutions available, face the situation proactively rather than resist it passively, make repayments on time, and protect your own credit.