A repayment plan is a formal structured approach for paying back a debt, agreed between the creditor and the borrower.
More specifically, the term is often used to describe a special agreement where a debt is restructured to make repayment easier, often in the case of arrears.
Mortgage repayment plans serve as a proactive measure to prevent further financial strain, particularly after a default, or if as the borrower you are suffering from financial hardships. These can be crucial in helping you regain financial stability while ensuring that lenders can recover the owed amounts.
In this article, we look at the various aspects of mortgage repayment plans, their benefits, downsides, and how they can be negotiated and re-structured to foster a win-win situation for both lenders and you.
What can lead to a repayment plan?
Normally, repayment plans are agreed upon when you default on a debt, missing a planned repayment.
Repayment plans are often arranged by mortgage lenders following a customer building up these missed payments, known as arrears.
Alternatively, sometimes individuals in financial difficulty attempt to negotiate a repayment plan before defaulting on their debt. This can have a variety of benefits including reducing your monthly payments and avoiding the damage caused to credit by a default.
Sometimes repayment plans will be arranged during a court hearing, often as part of a suspended or time order. The specifics of such arrangements would likely depend on your individual circumstances at the time.
What are the benefits of a repayment plan?
Repayment plans offer benefits for both you and the lender.
By agreeing to a repayment plan, you can:
- Avoid legal action: By agreeing to a repayment plan before the lender files an N5 Claim Form and initiating legal action, you can avoid court action. This can save you an awful lot of stress and money.
- Manage their payment terms: Repayment plans often offer an organised manageable way to repay a debt, with the payments divided into manageable amounts easing your financial burden.
- Reduce monthly costs: By organising an interest-only mortgage or a longer term of repayment, you can reduce your monthly mortgage costs, helping to salvage your personal finances.
- Make repairs to your credit score: Over time, by sticking to the terms of a repayment plan you can improve your credit score. While it may not cover the full impact of a default, over time it will make getting further lines of credit cheaper and easier.
The reason repayment plans work is that they offer benefits to the lender as well. This makes them much more willing to participate in such negotiations.
These benefits are:
- Increasing the likelihood of debt recovery: Lenders are often more likely to recover a greater portion of their outstanding loan if you continue to make payments towards the mortgage, compared to the scenario where they default leading to property repossession. This financial perspective makes lenders relatively flexible concerning repayment plans. If there is a fair chance of recovering the debt along with interest over time, many lenders prefer this over the immediate, but often lower recovery they could achieve through repossession.
- Maintaining and improving customer relationships: When a bank provides support to you during challenging times by facilitating a repayment plan, it not only helps you manage your financial situation but also cultivates a positive relationship. Such supportive actions can result in you continuing to use the bank in the future, and possibly recommending the bank to friends and family. This long-term customer relationship is beneficial for the bank, making repayment plans a favourable option.
What are the downsides to a repayment plan?
While organising a repayment plan may be the best way to deal with your mortgage arrears, they still come with negatives relative to paying your bills on time.
Downsides associated with a repayment plan can include:
- An extended debt period: Repayment plans often extend the period over which the debt is repaid to reduce the amount paid each month. While this reduces the amount you have to pay each month, it leads to you being in debt for longer, or in the case of an interest-only mortgage, potentially indefinitely. This can have a negative effect on mental health and personal growth.
- Interest accumulation: Depending on the terms of your repayment plan, interest on your arrears can continue to accrue. This could leave you owing more in total than you otherwise would have and paying a higher total cost over the lifetime of the loan.
- Impact on credit: While sticking to the terms of a repayment plan can have a positive effect on your credit rating, entering into one initially does not, and is likely to have a substantial negative impact on your credit score.
What are the different types of repayment plans?
There are a few broad types of repayment plans, although all are based on the concept of paying the loan off over a longer period.
Nonetheless, each has its specifics, and so it is worth examining them all in more detail.
Extended repayment plans: An extended repayment plan lengthens the term of the loan, thereby reducing the monthly payments. This plan can provide immediate financial relief to you, making it easier to manage monthly expenses. However, it is important to note that extending the term of the loan could result in you paying more interest over the life of the loan.
Graduated repayment plans: Graduated repayment plans start with lower monthly payments that gradually increase over time. This plan can be suitable for you if you expect your income to rise in the future. The gradual increase in payments can make budgeting and financial planning more manageable, though, like extended repayment plans, the total interest paid over the term may be higher.
Payment holiday or deferred payment plans: These terms refer to arrangements made with lenders to temporarily alleviate the burden of monthly payments during financial hardships or unforeseen circumstances. A payment holiday is a mutually agreed period during which you can pause your payments while, a deferred payment plan may involve postponing payments to a later date or spreading the missed payments out over a longer period, which can also entail temporarily reducing the payment amounts. While both provide short-term relief, they serve as temporary measures and not long-term solutions. It is essential to understand the specifics of the agreement with your lender, as the exact terms and implications may vary.
Interest-only repayment plans: An interest-only repayment plan allows you to pay only the interest charges for a specified period, lowering your monthly payments. Following this period, you can resume making regular payments towards both the interest and the principal. Interest-only repayment plans are often used by homeowners as one of the ways of avoiding having a home repossessed. This plan can provide temporary relief, but it is crucial to understand that the principal amount remains unchanged during the interest-only period.
How do you negotiate a repayment plan?
By taking a step-by-step approach, you can often negotiate with your bank to create a repayment plan which works for both of you.
1. Assess your financial standing: This step involves thoroughly evaluating your current financial situation. You should determine your total income, expenses, and existing debts and calculate how much you can realistically afford to pay towards your mortgage each month without compromising your basic living necessities.
Check your credit score as it might affect the negotiation process. If you have a relatively high credit score, this means you will be seen as more reliable, and banks are likely to offer you better terms.
It is also advisable to think about any upcoming financial changes, like a job change or new expenses, which might impact your ability to repay your debt. If you are going to be generating more income soon, your repayment plan could take this into account.
2. Gather necessary documentation: Collect all relevant financial documents that your lender may request. This includes recent payslips, bank statements, tax returns and a complete list of assets and liabilities.
You should also gather a clear record of your mortgage payments, including any missed or late payments.
3. Research your options: Look into the various repayment options that might be available to you. Understand the terms and conditions attached to each, and how they might impact your finances in the short and long term.
It can be a good idea to talk to a legal or financial adviser when doing this, as they can help you understand what a realistic repayment plan might look like. Some organisations offer free or cheap help to people struggling with debt. These include the Money Advice Service, National Debtline, and the Step Change Debt Charity.
4. Contact your lender: After looking through and understanding what your options might look like, it is time to contact your lender.
It is crucial to contact your lender early, ideally as soon as you anticipate financial problems, as this quick communication may open up more options.
While it is advantageous to communicate with your bank or lender as soon as you are experiencing financial difficulties, they will often still be willing and able to help you work out a repayment plan, even if you default on multiple payments.
5. Propose a realistic repayment plan: Based on your financial assessment, propose a repayment plan that you can adhere to. Be realistic in your proposal to ensure that you can meet the new payment terms and avoid future defaults.
6. Get everything in writing: Once you and your lender have agreed on a repayment plan, ensure that all the terms and conditions are documented in writing. Review the agreement carefully and consider having a legal professional look over it to ensure it aligns with your understanding.
7. Stick to the agreed plan: Adhere to the terms of the new repayment plan, making all required payments on time. If your financial situation changes, contact your lender again to discuss any necessary adjustments.
How to best implement a repayment plan?
The best way to implement a repayment plan varies depending on your individual circumstances, and how flexible your bank is.
It is critical that you prioritise the repayment plan as being manageable. If you cannot make the new payments, you will shortly default on your debt and your plan will not be worth anything.
On the other hand, deferring too much of the mortgage into the future can come back to bite you. The longer you have a debt, the more interest you will pay in the long term.
The ideal repayment plan balances these two factors to arrive at the best solution for you.
A repayment plan is a strategic arrangement between a creditor and you to facilitate the structured repayment of a debt. This is often initiated if as a borrower, you find yourself facing financial hardship or a default on a payment.
In the context of mortgages, repayment plans are very useful when attempting to mitigate financial strain, preventing legal action and potentially a house repossession.
While the benefits of agreeing to one of these plans include making payment terms more manageable and avoiding possession action, their downsides can lead to extended periods of debt and additional interest accruing. Ultimately this leads to a higher total amount to repay over the lifetime of the mortgage.
Nonetheless, through a well-negotiated repayment plan you and your lender can create a win-win, with you being able to keep the home you would have otherwise lost and the lender being able to avoid the losses in profit associated with a repossession.
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