When economic disruption strikes, private lenders face a challenge that sits squarely at the intersection of business judgment and legal obligation. Requests for loan forbearance — whether driven by market downturns, natural disasters, or broad economic shocks — require a structured response grounded in both legal compliance and sound portfolio management.
This article synthesizes key forbearance principles for private lenders navigating borrower hardship situations, drawing from industry best practices and the legal framework governing business-purpose loans.
Understanding Forbearance in the Private Lending Context
Forbearance is a temporary agreement between a lender and a borrower to suspend or reduce loan payments for a defined period. Unlike loan modification — which permanently changes loan terms — forbearance is a short-term accommodation that preserves the original loan structure while providing the borrower relief.
For private lenders making business-purpose loans, the legal landscape is meaningfully different from the regulated consumer lending environment. Private lenders generally operate outside of many federal consumer protection statutes that mandate specific forbearance protocols. This creates flexibility, but also responsibility: the absence of a legal mandate does not eliminate the operational and reputational considerations that inform a thoughtful forbearance policy.
Why Forbearance Policy Matters for Private Lenders
Private lenders who approach forbearance without a documented policy expose themselves to several risks:
- Inconsistent treatment of borrowers — without a written policy, lender decisions may appear arbitrary or discriminatory
- Regulatory scrutiny — regulatory bodies monitor how non-bank lenders treat borrowers during periods of economic distress; industry conduct shapes future legislation
- Portfolio deterioration — blanket denials or blanket approvals both carry risks; the goal is accurate assessment of individual loan viability
- Investor relations — fund managers and institutional capital sources expect a defined risk management framework that addresses workout scenarios
A well-developed forbearance policy gives lenders the structure to make consistent, defensible decisions that protect both borrowers and investors.
Legal Rights of Private Lenders vs. Regulated Consumer Lenders
It is critical that private lenders understand where they stand relative to consumer lending law. Business-purpose loans are generally exempt from state and federal protections that govern owner-occupied residential mortgages, including certain provisions of the CARES Act, state homeowner protection statutes, and CFPB oversight.
This means private lenders:
- Are not required to offer forbearance under most state or federal consumer protection frameworks (absent specific loan terms or applicable state law)
- Retain the right to pursue remedies under the loan documents, including acceleration and foreclosure, subject to any notice and cure periods specified in the deed of trust or mortgage
- May offer forbearance voluntarily, on whatever terms they deem appropriate, documented through a formal forbearance agreement
That said, private lenders should consult legal counsel before concluding that no legal obligations apply in a given situation. Certain states have enacted emergency legislation or regulations that impose additional obligations on all lenders, including private lenders. The legal framework can change quickly during times of economic disruption.
Key Elements of a Sound Forbearance Decision
When a borrower requests forbearance, the lender’s analysis should address the following:
1. Assess the Reason and Duration of Hardship
A temporary disruption to a borrower’s cash flow — caused by a tenant vacancy, a short-term market disruption, or a project delay — presents a very different risk profile than a systemic deterioration of the borrower’s financial position. Lenders should request documentation supporting the hardship claim and assess whether the underlying business plan remains viable.
2. Evaluate the Collateral Position
LTV ratios matter enormously in a workout scenario. A lender at 60% LTV on a stabilized property has significant cushion. A lender at 85% LTV on a mid-rehab property with a stalled project has limited margin for error. The collateral analysis should inform both the decision to grant forbearance and the terms under which it is offered.
3. Consider Construction Draws and Project Completion
For construction or rehabilitation loans, a borrower in financial distress presents a specific risk: a property that sits unfinished deteriorates in value and becomes harder to sell or refinance. Lenders who grant forbearance on these loans should condition relief on the borrower’s continued progress toward project completion. Monitoring draw activity closely and maintaining an open dialogue about construction progress is a practical way to protect collateral value.
4. Require Adequate Skin in the Game
Forbearance works best when the borrower has meaningful equity at stake. Borrowers with high LTV loans — particularly those at 90% or above — present significant risk in a deteriorating market. Prudent underwriting at origination, maintaining reasonable LTV limits, is the first line of defense against forbearance scenarios that end in loss.
5. Document Everything
Any forbearance accommodation must be documented in writing. A forbearance agreement should specify:
- The duration of the forbearance period
- Whether payments are suspended entirely or reduced
- Whether interest continues to accrue
- The terms for resuming regular payments
- Any conditions attached to the accommodation (e.g., continued construction progress, financial reporting)
- A clear statement that the lender is not waiving any default or releasing any rights under the original loan documents
A verbal agreement is not sufficient. Without proper documentation, the lender risks claims of waiver or estoppel that could impair its ability to enforce the loan terms after the forbearance period ends.
Communication Strategy During Forbearance
How a lender communicates forbearance decisions — to borrowers and to investors — has real consequences.
With borrowers, clear and prompt communication builds trust and helps preserve the relationship. A borrower who understands exactly what the lender expects during the forbearance period, and what happens at the end of it, is more likely to perform and less likely to create conflict.
With investors, transparency is essential. Fund managers should ensure that investor-level reporting accurately reflects the forbearance status of loans in the portfolio, the underlying rationale for the accommodation, and the projected recovery path. Investors who are surprised by workout situations after the fact tend to react much more negatively than those who were kept informed throughout.
Industry-Level Considerations
The private lending industry’s response to periods of widespread economic hardship has consequences beyond any individual lender’s portfolio. Regulators and legislators pay attention to how the industry as a whole behaves toward borrowers during distress. Lenders who adopt reasonable, documented forbearance policies and apply them consistently contribute to a regulatory environment in which the industry maintains the flexibility and light-touch oversight that has allowed it to serve borrowers whom traditional banks cannot or will not serve.
Lenders who take a blanket approach — either refusing all accommodations or granting them indiscriminately — create visible patterns that invite regulatory scrutiny and, in the worst cases, legislative action that constrains the entire industry.
The American Association of Private Lenders (AAPL) and other industry organizations have worked to develop model best practices frameworks that give lenders a starting point. Geraci LLP regularly participates in and contributes to these industry conversations, bringing a legal perspective to questions of forbearance policy and borrower communication.
Working with Legal Counsel on Forbearance
The forbearance agreement is a legal document. Getting it wrong — whether through imprecise language, improper characterization of the accommodation, or failure to preserve the lender’s enforcement rights — can be expensive to fix after the fact.
Geraci LLP’s banking and finance team works with private lenders across the country on loan workout and forbearance matters, including:
- Drafting and reviewing forbearance agreements
- Analyzing applicable state law obligations
- Advising on communication strategies for investor and borrower relations
- Coordinating forbearance agreements with ongoing construction draw management
- Preparing for foreclosure or other remedies if forbearance is not successful
If your portfolio includes loans that may require forbearance accommodations, or if you want to develop a written forbearance policy before you need it, contact the Geraci LLP team to discuss your situation.
Geraci LLP (949) 403-3488 90 Discovery, Irvine, CA 92618
