When is a loan considered to be a default?
A loan is considered to be in default when the borrower fails to repay the loan according to the terms agreed upon in the loan contract. This typically includes missing or late payments, or not paying the full amount owed. The specific definition of default can vary depending on the type of loan and the lender’s policies.
If a lender sees that you are likely to default, they will send you a default notice to notify you that you are behind payments and will give you a two weeks notice to catch up on your payment. While the notice won’t be put on record, if you do default, it will reflect in your credit history and this will be a major headache for you in the future should you wish to borrow again
When a lender gives you a line of credit, they also have a set of checklist to see that you are not likely to default on your loan. It’s a system designed to warn the lender early on so that they can take the necessary steps to ensure they don’t lose their repayments. Some of the indicators include:
- Late or missed payments: If a client has a history of late or missed payments, it can be a warning sign that they’re struggling to keep up with their loan obligations. this is a major red flag and most lenders could prefer never to lend to the client again.
- High debt-to-income ratio: If a client’s existing debt is too high compared to their income, they may be more likely to default on their loan. Like a company, a high debt to income is a clear indication of a person is likely to declare bankruptcy.
- Employment change: A change in employment status, such as a job loss or reduction in hours, can increase the risk of default as it may impact their ability to make loan payments.
- Financial distress: If a client is experiencing financial difficulties, such as high medical expenses or a significant decrease in income, it can increase the risk of default.
- Unforeseen events: Unforeseen events, such as natural disasters or personal emergencies, can also increase the risk of default as they can disrupt a client’s financial stability.
- Poor credit history: A client with a poor credit history, including a low credit score or a history of defaulting on previous loans, is more likely to default on a new loan.
- Loan purpose: If the loan is for a risky or speculative purpose, such as a high-risk investment, the risk of default may be higher.
- Inaccurate information: If the information provided by the client in their loan application is inaccurate or incomplete, it can increase the risk of default as they may be unable to repay the loan as agreed.
- Insufficient collateral: If the loan is secured, a lack of sufficient collateral can increase the risk of default as the lender may be unable to recover the loan if the borrower defaults.
These are some of the indicators that a client is likely to default on a loan, but the specific factors may vary depending on the type of loan and the lender’s individual lending policies. this indicator is a good checklist for you as a client to ensure you don’t fall on the wrong side of your lenders books (pan intended). Defaulting on your loan has some major consequences which we covered.
In the banking industry, a loan account is considered a Non-Performing Asset (NPA) based on a 90- 120 days delinquency.
What are some of the steps you can take to avoid defaulting?
- Create a budget: Start by creating a realistic budget that takes into account all of your expenses, including your loan payments. Your budget should have a comprehensive debt repayment plan which you must follow to ensure your debt obligation are taken care of.
- Make timely payments: Make sure to make all of your loan payments on time, as missed or late payments can have a significant impact on your credit score. As we had discussed on indicators of defaulting, late payments are likely to get you peneralized like you have already defaulted. if you are going to be late for an unavoidable reason, call your lender early and inform them of your conandrum so they can advise you accordingly and avoid receiving a default notice which will cause a lot of issues in the future
- Stay within your means: Avoid taking on more debt than you can afford to repay, and prioritize paying off high-interest debt first. This way you will always have a good debt-to-income ratio that wont burden your credit score. It is also important to remember that your income must support your persona; expenses and not just repay debts.
- Communicate with your lender: If you’re struggling to make your loan payments, reach out to your lender as soon as possible. They may be able to work with you to find a solution. A simple phone call can save you a lot of pain in the future, even your lender is a human being, they want to recover their debt not spend time trying to sale your collateral to recover it.
- Consider a loan modification: If you’re unable to make your loan payments, a loan modification may be an option. This involves changing the terms of your loan to make it more manageable.
- Seek financial counselling: Consider seeking the help of a financial counsellor or debt management expert if you’re having difficulty managing your debt.
- Prioritize essential expenses: If you’re struggling to make ends meet, prioritize your essential expenses, such as food, housing, and transportation.
- Avoid additional debt: Avoid taking on additional debt, such as credit card balances, until you’re able to get your current debt under control.
- Consider debt consolidation: If you have multiple loans, consider consolidating them into a single loan with a lower interest rate.
- Stay informed: Stay informed about changes in your financial situation and any changes to your loan terms to ensure that you’re able to make your loan payments on time.
By following these tips, you can help avoid defaulting on your loan and maintain a good credit history.