Requesting Mortgage Forbearance: Be Careful
Due to the rapid rise in the unemployment rate as a result of the Coronavirus, Congress passed the CARES Act which includes a provision that provides mortgage relief to homeowners that have federally-backed mortgages.
Due to the rapid rise in the unemployment rate as a result of the Coronavirus, Congress passed the CARES Act which includes a provision that provides mortgage relief to homeowners that have federally-backed mortgages. Homeowners are eligible for a 180 day forbearance on their mortgage payments which can provide much needed financial relief for individuals and families that are struggling due to the COVID-19 containment efforts. Even if you do not have a federally-back mortgage, some banks are voluntarily offering homeowners forbearance options on their mortgage payments. But before you choose this option, you should be aware of the following items:
How does forbearance work?
Who qualifies for mortgage forbearance?
What is the process for requesting a forbearance?
Does forbearance hurt your credit score?
What are the repayment options?
The hidden costs of forbearance
Other options for mortgage relief
How Does Mortgage Forbearance Work?
Mortgage forbearance allows homeowners to defer monthly mortgage payments for a specific period of time. Under the CARES Act, homeowners that qualify, will be able to delay their mortgage payments for the next 6 months. But it’s important to understand that “forbearance” delays mortgage payments, it does not forgive those payment. At some point in the future, you will have to make up for those missed payments.
Who Is Eligible For Mortgage Forbearance?
Under the CARES Act, homeowners that have federally-backed mortgages are eligible for a forbearance up to 180 days. But as I mentioned above, homeowners that do not have federally-backed mortgages may also be eligible but it’s at the discretion of the loan servicer. How do you know if you have a federally-backed mortgage? Here is a list of the federal agencies:
FHA
VA
Freddie Mac
Fannie Mae
USDA
Do You Have A Government Backed Mortgage?
If you are not sure whether or not your mortgage is backed by the federal government, there are a few ways to find out but we recommend not blindly calling the bank that issued your mortgage. The bank that issued your mortgage may be different than the company that “services” your mortgage. It’s not uncommon for lenders to sell the servicing rights of their mortgages to other companies. If you are considering applying for forbearance, you will need to consult with the loan servicer.
As you can image, these loan servicing companies are being overwhelmed right now with homeowners requesting forbearance of their mortgage payments. If you are able to determine whether or not you have a federally-backed mortgage yourself, it will save you time and frustration. Here are a few different ways to determine if your mortgage is backed by a federal agency:
FHA Insurance Payments: If you look at your mortgage statement and you see FHA insurance payments being made, your loan is backed by the FHA. You can also look at your mortgage closing documents, specifically your HUD form.
Fannie Mae & Freddie Mac Websites: Almost 50% of all mortgages issued in U.S. are backed by either Fannie Mae or Feddie Mac. You can run a search on their websites to determine if your mortgage is backed by either of those two agencies.
Contact Loan Servicer: If you are still unable to determine whether or not your mortgage is federally-backed, you can contact your loan servicer. The contact information for your loan servicer is usually listed on your monthly mortgage statement but if you don’t have access to your statement, you may be able to locate your loan servicer via the Mortgage Electronic Registration System
Mortgages Not Backed By A Federal Agency
If your mortgage is not backed by a federal agency, you still may be eligible for a mortgage forbearance but that will be at the complete discretion of your loan servicing company. You will need to contact your loan servicer but unlike federally-backed loans, they are not required to offer you a forbearance. You should be prepared to answer a number of questions such as:
Why are you applying for the forbearance?
How long do you need the forbearance for?
Details about the status of your income, expenses, and employment
The Forbearance Process
Whether you have a federally-backed mortgage or not, you will have to pro-actively reach out to your loan servicing company to request the forbearance; it does not happen automatically. If you qualify for the forbearance, there are two key pieces of information that you should obtain before that call is finished.
Determine the repayment terms for those missed payments
Request your forbearance agreement in writing
Repayment Options
Since you have to repay these missed mortgage payments at some point in the future, it’s incredibly important to understand the terms of the repayment. Some loan servicing companies are requesting a “balloon payment” which means if you are granted a 6 month forbearance, when you reach the end of that 6 month period, all of the missed mortgage payments are due in a lump sum amount; not a favorable situation for most homeowners. Here are the three most common repayment options:
Balloon Payment: All of the missed payments are due as a single lump sum payment at the end of the forbearance term. This is the least favorable option for homeowners.
Extended Term: This option extends the term of your mortgage by the length of the forbearance. If you receive a 3 month forbearance and you have a 30 year mortgage, they will extend the term of your 30 year mortgage by an additional 3 months. This is usually the most favorable option for borrowers.
Re-amortize The Loan: Unlike the “extend the term” option, the maturity date of your mortgage stays the same, and when you restart mortgage payments at the end of the forbearance period, they spread those missed payments over the remaining life of the mortgage. This will result in a slightly higher mortgage payment compared to your mortgage payment prior to the forbearance period.
Get The Forbearance Offer In Writing
With all of these moving parts, it’s extremely important to request that your loan servicer sends you the forbearance agreement in writing. You definitely want to make sure nothing was missed or miscommunicated otherwise you could damage your credit score, end up in a foreclosure situation, or have an unexpectedly large mortgage payment waiting for you at the end of the forbearance period.
Does Mortgage Forbearance Affect Credit?
If done correctly, a mortgage forbearance will not negatively impact your credit score.
Hidden Cost of Forbearance
While there are no late fees assessed on these missed mortgage payments associated with a forbearance agreement, there is additional interest that accumulates over the remaining life of the mortgage when the repayment option involves either an extended term or re-amortization.
Example: Homeowner has a $250,000 federally-backed mortgage, 4% interest rate, with 20 years left on the mortgage. This homeowners was financially impacted by COVID-19 and is granted a 6 month forbearance with an extended term repayment. How much additional mortgage interest did that individual pay over the remaining life of the mortgage due to that 6-month forbearance?
Answer: $3,159
So this option is not “free” by any means but it may be a reasonable price for homeowners to pay compared to the negative financial impact of missing mortgage payments without forbearance.
Other Options Beside Forbearance
If your bank does not grant you forbearance, or you want to consider other options, the CARES Act did open up other forms of financial relief to taxpayers in the form of:
Each option has it’s own pros and cons but you can read more about these options via the links above.
Michael Ruger
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Coronavirus Relief: $100K 401(k) Loans & Penalty Free Distributions
With the passing of the CARES Act, Congress made new distribution and loan options available within 401(k) plans, IRA’s, and other types of employer sponsored plans.
With the passing of the CARES Act, Congress made new distribution and loan options available within 401(k) plans, IRA’s, and other types of employer sponsored plans. These new distribution options will provide employees and business owners with access to their retirement accounts with the:
10% early withdrawal penalty waived
Option to spread the income tax liability over a 3-year period
Option to repay the distribution and avoid taxes altogether
401(k) loans up to $100,000 with loan payments deferred for 1 year
Many individuals and small businesses are in a cash crunch. Individuals are waiting for their IRS Stimulus Checks and many small business owners are in the process of applying for the new SBA Disaster Loans and SBA Paycheck Protection Loans. Since no one knows at this point how long it will take the IRS checks to arrive or how long it will take to process these new SBA loans, people are looking for access to cash now to help bridge the gap. The CARES Act opened up options within pre-tax retirement accounts to provide that bridge.
10% Early Withdrawal Penalty Waived
Under the CARES Act, “Coronavirus Related Distributions” up to $100,000 are not subject the 10% early withdrawal penalty for individuals under the age of 59½. The exception will apply to distributions from:
IRA’s
401(K)
403(b)
Simple IRA
SEP IRA
Other types of Employer Sponsored Plans
To qualify for the waiver of the 10% early withdrawal penalty, you must meet one of the following criteria:
You, your spouse, or a dependent was diagnosed with the COVID-19
You are unable to work due to lack of childcare resulting from COVID-19
You own a business that has closed or is operating under reduced hours due to COVID-19
You have experienced adverse financial consequences as a result of being quarantined, furloughed, laid off, or having work hours reduced because of COVID-19
They obviously made the definition very broad and it’s anticipated that a lot of taxpayers will qualify under one of the four criteria listed above. The IRS may also take a similar broad approach in the application of these new qualifying circumstances.
Tax Impact
While the 10% early withdrawal penalty can be waived, in most cases, when you take a distribution from a pre-tax retirement account, you still have to pay income tax on the distribution. That is still true of these Coronavirus Related Distributions but there are options to help either mitigate or completely eliminate the income tax liability associated with taking these distributions from your retirement accounts.
Tax Liability Spread Over 3 Years
Normally when you take a distribution from a pre-tax retirement account, you have to pay income tax on the full amount of the distribution in the year that the distribution takes place.
However, under these new rules, by default, if you take a Coronavirus-Related Distribution from your 401(k), IRA, or other type of employer sponsored plan, the income tax liability will be split evenly between 2020, 2021, and 2022 unless you make a different election. This will help individuals by potentially lowering the income tax liability on these distributions by spreading the income across three separate tax years. However, taxpayers do have the option to voluntarily elect to have the full distribution taxed in 2020. If your income has dropped significantly in 2020, this may be an attractive option instead of deferring that additional income into a tax year where your income has returned to it’s higher level.
1099R Issue
I admittedly have no idea how the tax reporting is going to work for these Coronavirus-Related Distributions. Normally when you take a distribution from a retirement account, the custodian issues you a 1099R Tax Form at the end of the year for the amount of the distribution which is how the IRS cross checks that you reported that income on your tax return. If the default option is to split the distribution evenly between three separate tax years, it would seem logical that the custodians would now have to issue three separate 1099R tax forms for 2020, 2021, and 2022. As of right now, we don’t have any guidance as to how this is going to work.
Repayment Option
There is also a repayment option associated with these Coronavirus Related Distributions, that will provide taxpayers with the option to repay these distributions back into their retirement accounts within a 3-year period and avoid having to pay income tax on these distributions. If individuals elect this option, not only did they avoid the 10% early withdrawal penalty, but they also avoided having to pay tax on the distribution. The distribution essentially becomes an “interest free loan” that you made to yourself using your retirement account.
The 3-year repayment period begins the day after the individual receives the Coronavirus Related Distribution. The repayment is technically treated as a “rollover” similar to the 60 day rollover rule but instead of having only 60 days to process the rollover, taxpayers will have 3 years.
The timing of the repayment is also flexible. You can either repay the distribution as a:
Single lump sum
Partial payments over the course of the 3 year period
Even if you do not repay the full amount of the distribution, any amount that you do repay will avoid income taxation. If you take a Coronavirus Related Distribution, whether you decide to have the distribution split into the three separate tax years or all in 2020, if you repay a portion or all of the distribution within that three year window, you can amend your tax return for the year that the taxes were paid on that distribution, and recoup the income taxes that you paid.
Example: I take a $100,000 distribution from my IRA in April 2020. Since my income is lower in 2020, I elect to have the full distribution taxed to me in 2020, and remit that taxes with my 2020 tax return. The business has a good year in 2021, so in January 2022 I return the full $100,000 to my IRA. I can now amend my 2020 tax return and recapture the income tax that I paid for that $100,000 distribution that qualified as a Coronavirus Related Distribution.
No 20% Withholding Requirement
Normally when you take cash distributions from employee sponsored retirement plans, they are subject to a mandatory 20% federal tax withholding; that requirement has been waived for these Coronavirus Related Distributions up to the $100,000 threshold, so plan participants have access to their full account balance.
Cash Bridge Strategy
Here are some examples as to how individuals and small business owners may be able to use these strategies.
For small business owners that intend to apply for the new SBA Disaster Loan (EIDL) and/or SBA Paycheck Protection Program (PPP), the underwriting process will most likely take a few weeks before the company actually receives the money for the loan. Some businesses need cash sooner than that just to keep the lights on while they are waiting for the SBA money to arrive. A business owner could take a $100,000 from the 401(K) plan, use that money to operate the business, and they have 3 years to return that money to 401(k) plan to avoid having to pay income tax on that distribution. The risk of course, is if the business goes under, then the business owner may not have the cash to repay the loan. In that case, if the owner was under the age of 59½, they avoided the 10% early withdrawal penalty, but would have to pay income tax on the distribution amount.
For individuals and families that are struggling to make ends meet due to the virus containment efforts, they could take a distribution from their retirement account to help subsidize their income while they are waiting for the IRS Stimulus checks to arrive. When they receive the IRS stimulus checks or return to work full time, they can repay the money back into their retirement account prior to the end of the year to avoid the tax liability associated with the distribution for 2020.
401(k) Plan Sponsors
I wanted to issue a special note the plan sponsors of these employer sponsored plans, these Coronavirus Related Distributions are an “optional” feature within the retirement plan. If you want to provide your employees with the opportunity to take these distributions from the plan, you will need to contact your third party administrator, and authorize them to make these distributions. This change will eventually require a plan amendment but companies have until 2022 to amend their plan to allow these Coronavirus Related Distributions to happen now, and the amendment will apply retroactively.
$100,000 Loan Option
The CARES Act also opened up the option to take a $100,000 loan against your 401(k) or 403(b) balance. Normally, the 401(k) maximum loan amount is the lesser of:
50% of your vested balance OR $50,000
The CARES Act includes a provision that will allow plan sponsors to amend their loan program to allow “Coronavirus Related Loans” which increases the maximum loan amount to the lesser of:
100% of your vested balance OR $100,000
To gain access to these higher loan amounts, plan participants have to self attest to the same criteria as the waiver of the 10% early withdrawal penalty. But remember, loans are an optional plan provision within these retirement plans so your plan may or may not allow loans. If the plan sponsors want to allow these high threshold loans, similar to the Coronavirus Related Distributions, they will need to contact their plan administrator authorizing them to do so and process the plan amendment by 2022.
No Loan Payments For 1 Year
Normally when you take a 401(K) loan, the company begins the payroll deductions for your loan payment immediately after you receive the loan. The CARES act will allow plan participants that qualify for these Coronavirus loans to defer loan payments for up to one year. The loan just has to be taken prior to December 31, 2020.
Caution
While the CARES ACT provides some new distribution and loan options for individuals impacted by the Coronavirus, there are always downsides to using money in your retirement account for purposes other than retirement. The short list is:
The money is no longer invested
If the distribution is not returned to the account within 3 years, you will have a tax liability
If you use your retirement account to fund the business and the business fails, you could have to work a lot longer than you anticipated
If you take a big 401(k) loan, even though you don’t have to make loan payments now, a year from the issuance of the loan, you will have big deductions from your paycheck as those loan payments are required to begin.
Michael Ruger
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
