Workout Agreement
Key takeaways
- A workout agreement is a negotiated contract between a borrower and lender to restructure a loan that is in default.
- Its goal is to help the borrower resume payments while allowing the lender to recover more of the loan than through foreclosure or litigation.
- Terms vary case-by-case; agreements can affect credit scores and may have tax consequences.
What is a workout agreement?
A workout agreement is a formal arrangement in which a lender and borrower agree to modify the terms of a loan that is past due. It typically involves waiving defaults and changing repayment terms so the borrower can meet obligations and the lender can avoid the costs and delays of foreclosure or other collection actions.
How it works
The lender and borrower negotiate changes intended to reduce the borrower’s immediate debt-servicing burden and improve the likelihood of repayment. The lender evaluates whether modification will likely yield better recovery than repossessing or foreclosing on collateral.
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Common goals:
* Prevent foreclosure or other collection remedies.
* Restore regular payments under revised, sustainable terms.
* Maximize recovery for the lender while preserving value for the borrower.
Common workout options
- Extending the loan term to lower monthly payments.
- Rescheduling missed payments into a catch-up plan.
- Temporarily reducing or suspending payments (forbearance).
- Changing the interest rate.
- Adding missed payments to the loan balance.
- Principal reduction or partial forgiveness in limited cases.
- Alternatives for businesses: negotiated liquidation or creditor arrangements.
Special considerations for borrowers
- Notify the lender early: Prompt communication increases the chance of a workable solution.
- Be honest and flexible: Lenders are not required to modify loans, so realistic proposals help negotiations.
- Get agreements in writing: Ensure the modification is documented and clearly describes rights and obligations.
- Credit impact: Modifications can still lower a credit score, though typically less severely than foreclosure.
- Tax implications: Debt forgiveness or reductions can be treated as taxable income in some cases; consult a tax professional.
- Seek advice: Consider legal or financial counsel for complex situations or business insolvency cases.
If you suspect unlawful discrimination in lending, you can report it to the Consumer Financial Protection Bureau (CFPB) or the U.S. Department of Housing and Urban Development (HUD).
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Bottom line
A workout agreement can be an effective alternative to foreclosure when both borrower and lender find it mutually beneficial. It provides flexibility to help borrowers get back on track while giving lenders a greater chance of recovering funds than through enforcement actions. Always document terms in writing and consider credit and tax consequences before finalizing an agreement.