# Workout Agreement: What It Is, How It Works

![Professional consultant is making a workout agreement with borrowers in regard to their mortgage loan.](https://www.investopedia.com/thmb/oVJL7d7E33UvPnYAKX-p78dxtW8=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/WorkoutAgreementWhatItIsHowItWorks-bcfa28bcfa6c4f8aa321c02790c3d4eb.jpg)

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## What Is a Workout Agreement?

A workout agreement is a contract mutually agreed to between a lender and borrower to renegotiate the terms on a loan that's in default, often in the case of a mortgage that is in arrears. Generally, the workout includes waiving any existing defaults and restructuring the loan’s terms and [covenants](https://www.investopedia.com/terms/c/covenant.asp).

A workout agreement is only possible if it serves the interests of both the borrower and the mortgage lender.

### Key Takeaways

*   A workout agreement allows a borrower in default and their lender to renegotiate the terms of a loan.
*   The purpose is to accommodate the default borrower so that the lender has a more likely chance of recovering the loan principal and interest without foreclosure, making it mutually beneficial.
*   Not all lenders are willing to make a workout agreement, and terms will vary on a case-by-case basis.

## How Workout Agreements Work

A mortgage workout agreement is intended to help a borrower avoid [foreclosure](https://www.investopedia.com/terms/f/foreclosure.asp), the process by which [the lender assumes control of a property](https://www.investopedia.com/terms/o/other-real-estate-owned-oreo.asp) from the homeowner due to a lack of payment as stipulated in the mortgage agreement. At the same time, it helps the lender recoup some of their funds that would otherwise be lost in the process.

The renegotiated terms will generally provide some relief to the borrower by reducing the [debt-servicing](https://www.investopedia.com/terms/d/debtservice.asp) burden through accommodative measures provided by the lender. Examples of relief can include [extending the term](https://www.investopedia.com/articles/personal-finance/091615/difference-between-restructuring-and-refinancing.asp) of the loan or rescheduling payments. While the benefits to the borrower of a workout agreement are obvious, the advantage to the lender is that it avoids the expense and trouble of payment recovery efforts, such as foreclosure for workouts in real estate or [a collection lawsuit](https://www.investopedia.com/articles/pf/09/fighting-collection-lawsuits.asp).

Other types of workout agreements can involve different kinds of loans and even involve [liquidation](https://www.investopedia.com/terms/l/liquidate.asp) scenarios. A business that becomes insolvent and cannot meet its debt obligations may seek an arrangement to appease creditors and shareholders.

## Special Considerations With Workout Agreements

For borrowers, general best practices to consider when negotiating or thinking about negotiating a workout agreement with a lender include the following:

*   **Providing ample notification**: Giving the lender advance notice of an inability to meet any and all debt obligations is a good courtesy to extend. Most lenders will likely be more accommodating when borrowers seek a workout agreement if they know that [default](https://www.investopedia.com/terms/d/default2.asp) could be an issue. Providing notice engenders confidence that the borrower is on top of their [loan management](https://www.investopedia.com/terms/l/loan_servicing.asp) and interested in being a reliable business partner the lender can trust.
*   **Being honest and flexible**: A lender is not under any obligation to [restructure](https://www.investopedia.com/terms/r/restructuring.asp) the terms of a loan, so it is incumbent on the borrower to be honest, direct, and flexible. However, the lender will likely want to limit its losses and maximize recovery of the loan, so it is likely in the lender’s best interest to help the borrower to the extent it can.
*   **Considering the credit score and tax implications**: Any adjustment to the terms of a loan in a workout scenario could negatively affect the borrower’s [credit score](https://www.investopedia.com/terms/c/credit_score.asp), though likely not as badly as a foreclosure would. With regard to taxes, the [Internal Revenue Service (IRS)](https://www.investopedia.com/terms/i/irs.asp) typically treats any loan reduction or cancellation as [taxable income](https://www.investopedia.com/terms/t/taxableincome.asp), which means the borrower could end up owing a larger tax amount in the year that the workout agreement goes into effect.

> **Warning**
>
> Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau (CFPB) or with the United States Department of Housing and Urban Development (HUD).

## What Is a Workout Agreement?

A workout agreement is a contract mutually agreed to between a lender and borrower to renegotiate the terms on a loan that is in default, often in the case of a mortgage that is in [arrears](https://www.investopedia.com/terms/a/arrears.asp).

## What Are Some Workout Options?

A lender might extend the length of the mortgage, add missing payments to the loan, or change the interest rate.

## Why Would Someone Agree to a Workout Agreement?

A workout agreement offers solutions to borrowers who are struggling to make their mortgage payments. By working out a payment arrangement, the lender can continue to earn payments, and the borrower avoids foreclosure.

## The Bottom Line

Workout agreements can prevent foreclosure by renegotiating the terms of the loan so the borrower is able to make payments. Workout agreements are always mutually beneficial to the borrower and the lender, so it's a good option for borrowers struggling to make payments who might otherwise lose their homes.

> **Article Sources**
>
> 1.  Internal Revenue Service. "[Topic No. 431 Canceled Debt – Is It Taxable or Not?](https://www.irs.gov/taxtopics/tc431)"
>     
> 2.  Federal Trade Commission, Consumer Advice. "[Mortgage Discrimination](https://consumer.ftc.gov/articles/mortgage-discrimination)."