A workout agreement is a mutually agreed contract between a lender and borrower to renegotiate the terms of a loan that is in default, often in cases such as mortgage arrears. Typically, the arrangement includes waiving existing defaults and restructuring loan terms and covenants.
A workout agreement only occurs if it serves the interests of both the borrower and the lender. It can help preclude costly processes like foreclosure, balancing mutual benefits.
Key Takeaways
- A workout agreement facilitates the renegotiation of loan terms for borrowers in default.
- It aims to offer relief to the borrower and maximize the lender’s chance of recovery without resorting to foreclosure.
- Not all lenders are amenable to such agreements, and terms are usually case-specific.
Understanding Workout Agreements
The main goal of a mortgage workout agreement is to help a borrower avoid foreclosure, the process by which the lender takes control of a property due to non-payment as defined in the mortgage agreement. This also enables the lender to recoup some of the funds that would otherwise be lost.
Renegotiated terms generally provide relief to the borrower by reducing the debt-servicing burden through accommodating measures by the lender. These can include extending the loan term or rescheduling payments. For the lender, it avoids the expense and complications of payment recovery processes such as foreclosure or a collection lawsuit.
Workout agreements aren’t limited to personal mortgages. They can apply to different loan types and involve scenarios like liquidation, where an insolvent business seeks an arrangement favorable to creditors and shareholders.
Special Considerations with Workout Agreements
For borrowers considering or negotiating a workout agreement with a lender, bear in mind these best practices:
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Providing Ample Notification: Give the lender advance notice of any inability to meet debt obligations. This proactiveness encourages the lender to be more accommodating, as it demonstrates the borrower’s diligence in loan management and reliability as a business partner.
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Being Honest and Flexible: The lender isn’t obligated to restructure the loan, so honesty, directness, and flexibility are crucial. It’s often in the lender’s best interest to help borrowers, balancing the effort to limit losses while maximizing loan recovery.
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Considering Credit Score and Tax Implications: Any workout agreement adjustment could impact the borrower’s credit score, albeit not as severely as foreclosure. Furthermore, the IRS may treat any loan reduction or cancellation as taxable income, potentially increasing the tax liability in the affected year.
Mortgage lending discrimination is illegal. If you believe you’ve been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, you can file a report to the Consumer Financial Protection Bureau or the U.S. Department of Housing and Urban Development (HUD).
Related Terms: foreclosure, loan restructuring, debt servicing, loan covenants, mortgage arrears.
References
- Internal Revenue Service. “Topic No. 431 Canceled Debt – Is It Taxable or Not?”
- Federal Trade Commission, Consumer Advice. “Mortgage Discrimination”.
