Why Loan Default Is Not the End of the Road for You

The availability of loans has made owning a house or a car a cherished aspiration for many individuals. In recent years, with an improved standard of living, particularly in urban areas, even those who were once cautious and hesitant about taking loans are now willing to assume financial obligations to fulfil their leisure needs.

Acquiring a loan affects your cash flow through regular EMI (Equated Monthly Instalment) payments. However, what happens if you encounter a job loss or are trapped in a debt cycle due to excessive commitments? In such situations, the possibility of defaulting on your loans becomes likely. Defaulting occurs when a borrower consistently fails to make payments to the lender according to the agreed-upon schedule at the time of loan disbursement.

Now, the question arises: Is loan default the end of the road, and do you have to relinquish ownership of the asset for which the loan was obtained?

We all understand the significance of having credit access to fulfil both short-term and long-term financial goals. Defaulting on a loan may seem like the end of the road, as it can result in the loss of credit privileges. However, this is not entirely true.

When faced with a situation where meeting your loan obligations becomes difficult, it is crucial not to avoid the lender. Understand that banks or lending institutions are aware that there can be legitimate reasons for a borrower's inability to make timely payments, such as job loss or being confined to bed due to an accident, provided you have consistently paid your EMIs on time before unfortunate circumstances occur.

Hence, in such a situation, it is advisable to initiate a conversation with the bank or financial institution. Depending on the sincerity of your intentions and the circumstances surrounding your case, the bank may explore various viable solutions that are mutually acceptable. This approach benefits both the borrower, as they can retain ownership of their asset, and the bank, as it avoids adding to its Non-Performing Assets (NPA) portfolio.

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Here are a few actions you may take when you are unable to repay your EMIs:

1. Loan Rescheduling:

After assessing your financial situation, if the bank determines that it is challenging for you to pay the EMI, they may be open to rescheduling your debt by extending the loan tenure. This would result in a reduced monthly EMI commitment. However, remember that it would lead to higher interest payments in the long run. It is advisable to consider the immediate relief it can provide in your current circumstances as well as the total interest outgo in the long term. Once your situation improves, you can negotiate with the bank to revert to your previous or higher EMI or even consider prepaying the loan to save on excessive interest payments (subject to pre-payment penalties).

2. Payment Deferment:

If you anticipate an increase in cash flow in the near future due to factors like a job change, you can request temporary relief from the bank for a few months. The bank may agree to this, but penalties may be imposed for not adhering to the original repayment schedule.

3. Loan Restructuring:

In the case of housing loans, banks have provisions for loan restructuring, such as extending the loan tenure. However, the bank must perceive the reason for default as genuine. The Reserve Bank of India (RBI) has issued guidelines on loan restructuring, including limitations on tenure extensions. If necessary, selling the collateral with the borrower's cooperation can be considered the next step.

4. One-time Settlement:

If you express your willingness to repay the loan and communicate your current financial condition to the bank, they may be willing to negotiate a one-time settlement on a case-by-case basis. This allows you to clear your loan at a reduced amount, as the bank may waive certain charges. If your financial situation is extremely dire, filing for bankruptcy may be necessary to relieve yourself from the loan obligation.

5. Conversion of Unsecured Loan:

Banks typically have stricter policies regarding unsecured loans. In such cases, borrowers can choose to convert the unsecured loan into a secured one by offering collateral. This can result in a lower interest rate and subsequently reduce the burden of EMIs.

Avoiding the problem is not a solution. It not only causes emotional stress but also leads to asset loss. Demonstrating your intent to repay the loan is crucial. It is also in the bank's best interest to prevent the loan from becoming non-performing. Therefore, it is wise to engage in a dialogue with the bank as soon as you realise that you may struggle to meet your obligations. Waiting until the last moment should be avoided, as proactive communication can help overcome temporary financial crises.

What exactly happens when you default on the loan?

If none of the aforementioned alternatives work, the bank will proceed with asset repossession as a means to recover the outstanding dues after providing you with a grace period for repayment. So, what exactly happens when you cannot repay the loan even after the grace period?

When a borrower fails to make several loan EMIs, the lender typically initiates the recovery process after sending multiple notices. Under the SARFAESI (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interests) Act, in the case of secured loans like home loans, two-wheeler loans, and car loans, the bank has the authority to repossess the asset.

However, the lender cannot initiate repossession without providing sufficient notice to the borrower. If the outstanding amount is not paid within the given time frame, the lender can commence the recovery process and take possession of the asset. Apart from the notice period, the lender must follow legal procedures and adhere to guidelines outlined in the SARFAESI Act before initiating repossession.

For unsecured loans, the lender can take legal action against the defaulter by approaching the court to recover the outstanding amount. The court will issue a notice to the defaulter, summoning them to appear and present their case. If the court determines that the defaulter has a valid reason for not repaying the loan, it may provide them with protection and assistance.

However, if the court finds that the defaulter lacks a genuine reason for non-repayment or is involved in fraudulent activities, it may rule in favour of the lender and permit them to recover the outstanding amount.

To safeguard the rights of borrowers during the recovery process, several legal provisions are in place:

1. Adequate Notice:

Borrowers have the right to receive timely and sufficient notice before the lender sells their assets in case of loan default. In India, once a borrower's account is classified as a Non-Performing Asset (NPA) due to non-payment for more than 90 days, the lender issues a 60-day notice, allowing the borrower to repay the outstanding EMIs. If the borrower still fails to make payments, the lender can sell the collateralised assets to recover the loan amount. However, even in this situation, a 30-day public notice is required before auctioning the assets. This grants the borrower additional time to make payments or explore alternative funding options. Adequate notice ensures that the borrower has an opportunity to protect their assets or challenge the auction process.

2. Fair Valuation of Assets:

Borrowers have the right to receive a fair market value for their assets when they are sold by the lender in the event of loan default. Before the asset sale, the lender must issue a public notice detailing the sale, including the fair market value, reserve price, auction venue, date, and time. Valuers appointed by the lender determine the sale price. If the borrower believes the asset is undervalued, they can contest the auction or introduce an alternative buyer who is willing to pay a higher price. In such cases, the lender is obliged to sell the asset to the new buyer at a higher price. This right ensures that borrowers are not disadvantaged by the sale of their assets at undervalued prices, which could further hinder their ability to repay the loan.

3. Balance of Auction Proceeds:

Borrowers have the right to receive any surplus money from the sale of their assets after clearing the dues and liabilities to the lender. For instance, if the lender sells a property to recover outstanding home loan dues and the sale amount exceeds the borrower's debt, the borrower is entitled to receive the surplus amount as per the law. This provision prevents the lender from unjustly benefiting by retaining more funds than necessary and ensures that borrowers receive any excess proceeds from the asset sale.

4. Humane Treatment:

During the recovery process, lenders must ensure that their appointed recovery agents treat borrowers with fairness and respect. Agents are prohibited from harassing or intimidating borrowers and can only meet with them at convenient times and locations. Visits must be scheduled between 7 am and 7 pm, and standards of decency must be upheld. If borrowers experience physical or mental harassment from recovery agents or their family members, they can file a complaint with the lender or banking ombudsman officers. Lenders are required to take appropriate action to ensure borrowers are treated humanely and that their rights are protected.

What should you do when you are on the verge of defaulting on a loan?

If you find yourself unable to repay a loan, you should take immediate action by contacting your lender and explaining your situation. By doing so, you may be able to negotiate a repayment plan that suits your current financial circumstances. This could involve restructuring your loan or reducing the monthly instalment (EMI) amount, making it more manageable for you to fulfil your obligations. Ignoring loan repayments can lead to additional fees, penalties, and negative effects on your credit score. Therefore, being proactive and transparent with your lender is crucial to find a mutually beneficial solution.

In certain circumstances, such as the unfortunate event of a family member's death, health issues, or job loss, lenders may offer an "EMI holiday" or moratorium period. This temporary relief allows borrowers to temporarily suspend their loan repayments for a specified period, typically a few months, providing them with some financial breathing room. However, it is advisable to carefully review the terms and conditions of such arrangements with your lender, as they may result in increased interest payments over the long term.

Experiencing difficulties in repaying a loan can be overwhelming, but borrowers in India are safeguarded by various rights that shield them from unjust treatment by lenders and recovery agents. The rights, including adequate notice, fair asset valuation, the balance of auction proceeds, and humane treatment, are in place to ensure borrowers are treated fairly and with respect during the loan recovery process. It is crucial for borrowers to be aware of these rights and to seek assistance from their lender or banking ombudsman officers if they believe their rights are being infringed upon. By understanding and asserting these rights, borrowers can navigate the loan recovery process more confidently and effectively.

KETKI JADHAV is a Content Writer at PersonalFN since August 2021. She is an MBA (Finance) and has over seven years of experience in Retail Banking. Ketki specialises in covering articles around banking, insurance, personal finance, and mutual funds and has been doing it for over three years now.

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Disclaimer: This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision.