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Why you shouldn’t be in default on credit

Due to Covid-19, retail lenders faced several challenges. On the one hand, the demand for small loans has risen as lockdowns affect livelihoods; on the other hand, the recovery rate has slowed. As a result, the rise in loan defaults has lowered the creditworthiness of borrowers.

“The creamy layer or low-risk borrowers saw their creditworthiness drop by around 5 percent from March 2020 to March 2021,” said Subhrangshu Chattopadhyay, national sales head, CRIF High Mark, a credit bureau recognized by the RBI. A credit score shows your creditworthiness. Because of this, lenders have tightened their credit guidelines. Most loans are only granted to existing customers with good credit ratings. A CIBIL score of 750 or higher is ideal for taking out loans. If your score is below 750, you will find it difficult to get loans from banks and NBFCs. If it’s near 750, you can get loans but at a higher interest rate.

While the trend of increasing loan defaults affects lenders, defaults have serious consequences for borrowers as well. First, it can affect his ability to get a loan in the future. Second, even if such a person is able to take out a loan, it will come at much higher interest rates. A failure that is declared “willful” can also lead to criminal proceedings. Here are the facts about the consequences of a loan default for borrowers.

Trend reversal: small is big

Travel, weddings, home renovations, down payments on a home, used cars, educating children, and paying back loans with higher interest rates were some of the main reasons people took out loans before Covid-19. After the outbreak of Covid-19, the trend shifted towards consumption-related and essential expenses. “Borrowing related to travel has slowed down. People are now borrowing for home renovations, paying off high-interest debt and paying home down payments, ”said Gaurav Chopra, founder of IndiaLends, an online loan aggregator.

According to the RBI’s Financial Stability Report, the industrial sector’s share of bank credit has decreased in recent years, while the share of personal credit has increased. In 2014, personal loans accounted for 16.2 percent of total loan volume. This rose to 26.3 percent in 2021. The share of smaller loans is also increasing. A report by TransUnion CIBIL and Google shows a 23-fold increase in loans to up to Rs 25,000 between 2017 and 2020. The proportion of ‘

The trend is also reflected in the credit card numbers of banks. According to RBI data, the value of transactions via credit cards at ATMs and point-of-sale terminals increased by 23 percent from March 2020 to June this year.

Adhil Shetty, CEO and co-founder of BankBazaar.com, says easing KYC norms has made it easier for credit card issuers to serve customers in Tier II and Tier III cities. “As a consequence, the demand for credit cards from non-metros continues to peak. The proportion of non-metros in total applications rose to 35 percent in FY21, compared to 24.8 percent in FY20, ”he adds.

Increase in retail NPAs

The downside of the increasing popularity of retail lending has been an increase in non-performing assets (NPAs) at most of the major banks. ICICI Bank, the country’s second largest private lender, added Rs 6.773 billion gross NPAs from retail and commercial banking portfolios in the first quarter of FY22, compared to Rs 4.355 billion in the fourth quarter of FY21. Axis Bank reported Rs 6,518 crore gross slippages compared to Rs 5,285 crore in the fourth quarter of last year. “Axis’ slip-ups were dominated by retail credit,” said a report by ICICI Securities.

Credit Bureau CRIF High Mark Agrees Credit Defaults Have Risen During Covid. The credit platforms have become cautious as a result. A recent report by PwC Equifax says that over 70 percent of credit managers have changed their standards, especially for those with poor credit histories, in an attempt to preserve asset quality. Online lenders are rejecting 45-50 percent loan applications after the pandemic. This is mainly because they are now factoring in additional parameters for underwriting such as recession, unemployment and insurance claims.

As people become more comfortable taking on debt and new lenders increase both online and offline, both borrowers and lenders need to act responsibly to avoid problems later on. Lenders, says Chopra of IndiaLends, have already become cautious when it comes to underwriting. Likewise, borrowers should be responsible and do their best to repay the loan. Failure to do so could result in serious consequences.

Consequences of default

Credit history takes a punch: The lender informs Schufa of the payment status monthly or when the loan installment is due. While a few days delay can be ignored, any payment that is delayed beyond 30 days will be reported to the credit bureau. This can have some impact on the person’s credit profile. However, a delay of 30-60 days will definitely tarnish the borrower’s credit history, while a delay of more than 60 days can severely affect creditworthiness.

A low credit score reduces a person’s ability to borrow in the future. “Today you might have borrowed a phone or a two-wheeler, but next time you will most likely have a bigger need or an emergency. You may be denied the loan due to bad credit, ”says Chopra of IndiaLends.

Online loan platforms that grant small loans are even more conservative. Even a single day late, says Bhavin Patel, co-founder and CEO of LenDenClub, can put the borrower on the list of defaulters. “A defaulting borrower will no longer be able to take out a loan in the future unless he pays back the older loan on our platform.”

Higher interest rate: Lenders today link the interest rate to your creditworthiness. Bad credit increases your borrowing costs and reduces your long-term savings. BankBazaar.com’s Shetty explains. “On a home loan of Rs 50 lakh for 20 years at a low interest rate of 6.8 percent, the total interest paid would be Rs 41.60 lakh. But if your credit was bad and you had to pay 8.5 percent on the same loan, your interest payment would be Rs 54.13 lakh. So you pay almost 12.53 lakh Rs more. “

For secured credit categories like home loans, the difference will be smaller – 10-200 basis points in most cases. For example, two very large home financiers have a 70 basis point and 125 basis point difference, respectively, between their lowest and highest interest rates, Shetty says. With unsecured categories like personal loans, the difference can be much bigger. “A private bank pays interest on personal loans between 10.5 percent and 19 percent.” You can save this money for other life goals such as investing in retirement or financing your child’s education.

Fintech loan platforms are one step ahead. Their algorithms adjust the interest rates according to the current default rate in order to minimize the impact on your portfolio. For example, in the first quarter of 2020, IndiaLends increased its lending rates by 0.8 percent as the default rate on its platform rose by one percentage point.

Legal implications: Loan defaults are a civil offense. However, the lender may attempt to cash blank checks from the borrower, says Shetty of BankBazaar.com. Failure to cash a check for lack of money is a criminal offense.

If a customer does not pay within 90 days, the case is usually referred to legal action. The lender may, after 180 days of default, bring proceedings against the borrower under Section 138 of the Negotiable Instruments Act of 1881. If the borrower does not pay despite the ability to do so, the RBI can declare him to be “willful default in payment”. However, if he is unable to pay for valid reasons, he can reach an agreement with the lender that gives him more flexibility to pay.

However, to date, most fintech lenders disbursing small loans have not faced such cases. “These are tough and high-level steps. We have not yet seen a case like this. In most cases, when the customer reaches the court, they offer to settle the loan, ”says Bhavin Patel from LenDenClub.

Real estate auction: In the case of secured loans such as a home loan, the lender has the right to auction the property through the judicial process. Likewise, the lender can confiscate the vehicle in the case of car loans. Lenders can also auction the borrower’s gold if the borrower does not repay the loan against the yellow metal. However, it must give the borrower 30 days before taking such a step.

Job loss: Most companies do not hire people to be involved in criminal activities. For certain senior positions, especially in industries like financial services, companies review the candidate’s credit history to see if he or she is trustworthy. “A bad credit history will make it difficult for a defaulting borrower to get a good job,” says Chopra of IndiaLends. Criminal proceedings also have a negative impact on the defaulting person’s passport.

Should you take out one loan to repay another loan?

“If it saves money, it definitely does,” says Chopra. For example, a credit card can have a very high interest rate of around 3.5 percent a month or 42 percent annually. “Taking out a personal loan that starts at 10-12 percent to pay back the credit card debt would be a good strategy,” he says. Most people can get a personal loan at an annual rate of 14-15 percent.

“Even if the intent is to refinance a home loan because it will save the borrower many rupees over the life of the loan, it is a good idea,” says BankBazaar’s Shetty. But if the person’s credit habits stay bad, refinancing may not help, he adds.

The second loan is to be used to repay existing high-interest loans. It shouldn’t add to the debt burden, experts say. Credit must be used wisely. The generally recommended rule is to use 30 percent of your credit limit. “The more you use your credit limit, the greater the impact will be on your score,” says Shetty.

Borrower Rights

First and foremost, borrowers have the right to be treated fairly and politely. “No lender can harass or intimidate borrowers,” says Shetty. Lenders should send notices, messages and emails to the borrower in the event of default. If the loan has become an NPA due to 90 days late payment, the bank or financial institution must issue a 60-day period to repay the contributions.

The defaulting party is also entitled to the difference earned by the lender (through the sale of the confiscated asset) beyond the due date, Shetty says.

The defaulting person is also given the right to due process, which can include a moratorium, restructuring or even a one-off settlement.

@avn_kaur


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Richard Dement

The author Richard Dement