WHAT is Distressed Borrower

A distressed borrower is a borrower who is unable to fully repay their debt on time, due to financial difficulties. A distressed borrower can be either a person or a business whose income falls due to unforeseen circumstances.

Distressed borrowers can also become distressed if they simply don't understand the terms of the loan. In the late 2000s, subprime mortgage borrowers often became distressed borrowers because they were issued loans they didn’t understand and couldn’t afford. Typically, lenders have the incentive to only issue loans that can be repaid, but the structure of the late 2000s mortgage market encouraged reckless lending, because mortgage originators usually didn't assume any repayment risk.

BREAKING DOWN Distressed Borrower

Distressed borrowers sometimes have different options to get current on their loans, as lenders have the incentive to find a way for borrowers to repay their debt, even if it means being repaid late or in less than the full amount owed. The most common strategies for distressed homeowners are forbearance, reinstatement, loan modifications or a short sale.

Strategies for Distressed Borrowers

A distressed borrower can request that a lender grant them forbearance, or the suspension of payment obligations for a specific period of time. A lender typically won’t agree to this option unless it is required to do so by law, because any delay in the repayment of a loan will reduce the value of that loan in the open market. The federal government, however, offers forbearance options for distressed borrowers of student loans, and some private student loan issuers are also required to offer forbearance options.

Lenders more often require that a borrower follow the reinstatement strategy, in which a borrower pays the delinquent amount in one lump sum. Depending on the terms of a loan, a lender might allow a borrower to reinstate without penalty, if their payment falls within a predetermined grace period.

Another strategy for distressed borrowers are loan modifications, which lenders will offer to either lower the total repayment amount required by the borrower, or extend the length of time given to repay the full loan amount. Lenders will sometimes offer a loan modification if they are afraid that absent the modification, the borrower will default entirely on his obligations.

Distressed mortgage borrowers have the option in some cases of a short sale, whereby they sell their property at a loss and pay their mortgage lender less than the full amount they owe. Laws regulating short sales vary state by state, and in some jurisdictions, mortgage lenders are forced to accept these loss-inducing arrangements.