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In simple words, a loan default happens when a borrower breaches a decided term of the loan agreement. Generally, this occurs when a borrower does not make the agreed upon instalment payments. This results in the lender resorting to legal action against the borrower.
Loan default happens when a borrower breaks or failing to observe a law, agreement, or code of conduct which was decided in the loan agreement payments as per the conditions mentioned in the loan agreement. This can result in legal action against the borrower by the lender.
The Federal Reserve maintains data on loan default rates across a range of loan types. There are typically fewer defaults on business loans, compared to consumer loans, because lenders have higher qualification standards for business loans. In the fourth quarter of 2018, 0.94% of borrowers defaulted on commercial and industrial loans. In contrast, 2.34% of consumer loans went into default. Defaults are more common on credit cards, with an average loan default rate of 2.54%.
The circumstances that trigger loan default will vary based on your lender and type of loan. Some lenders count one missed payment as a default. However, most wait until you’ve missed multiple payments, there are insufficient funds in your bank account to collect the payment, or until a payment is at least 30 days late before considering your loan to be in default.
As soon as your loan goes into default, the lender will contact you. As time goes by, your lender will become more aggressive. The lender’s remedies will vary based on the specifics of your loan agreement, but here are the general loan default consequences:
1. Drop-in CIBIL Score
Every a single default in an instalment is reported to credit agencies by the lenders. This leads to a drop in your personal as well as business credit scores. This further decreases the chance of being approved for any loan in the future.
2. Liquidation of Assets
If you had taken a secured business loan against collaterals, the lending financial institute might sell the assets you had provided as collateral to foreclose the mortgage. If you had signed a personal guarantee for an unsecured loan or provided a lien to your business assets then even in case of unsecured loans, your assets can be seized for repayment of the loan.
3. Declaring Bankruptcy
If you default on your loan, the lender will start legal proceedings in order to recover the loan amount. In case of secured loans, the collateral will be seized. For unsecured loans, as discussed earlier, lenders will sue you for defaulting on the loan. As per the courts ordered method, the loan will be recovered. However, if the lender is still not able to recover the loan amount, then your business may have to file for bankruptcy.
As seen above, defaulting on your business loan has adverse long-term and short-term effects. There are numerous available options in case you are finding it difficult to repay your loan. Below are a few pointers that would prevent you from defaulting on your business loan.
4. Increased Rate of Interest for Future Loans
Once your CIBIL score drops, there are less chances to get approved for other loans in the near future. However, you may get approved for some loans depending on the lender, but in that case, the interest charged will be higher than others. So, this will affect your current loan repayment as you need to pay a higher EMI & future loan approvals too.
5. Legal Action or Foreclosure
In case of a business loan default, depending on whether you have applied for a secured or unsecured loan, the consequences vary. In a secured loan, a foreclosure will allow the lender complete authority of all your assets and properties mentioned as collateral in your loan agreement. Generally, they sell the collateral in a private or public auction to recover their losses.
In the case of an unsecured loan, the lender generally charges you a late fee. However, even in the case of an unsecured loan, the lender requires a personal guarantee or a lien to your business assets. Therefore, on further failure, the lender can file a lawsuit against your business.
6. Difficulty in getting approved for Loans in Future
Once you default on any kind of loan, whether business or personal it reduces your credit score, this makes it extremely difficult to procure any loan in the future mostly for your business. Hence, you need to find alternative ways to fund your business in the future.
7. Increase in Fees
In case of an unsecured business loan, as you have not provided any collateral in exchange for the business loan, lenders will charge a high late fee when you default on your loan terms. This may only be the first step they take to recover their losses and could be followed up with legal action as well.
1. Privacy of Borrower
Lenders sometimes engage recovery agents to coerce borrowers to repay their loans. The borrower’s privacy is to be respected. These agents can contact the borrower at a place specified by him. If not specified, they can contact him either at his home or workplace.
2. Right to Fair Valuation of Assets
The value of the property is often much more than the total dues of the lender. However, the lender may only be interested in realising as much value so that the dues are recovered, which may not be in the best interest of the borrower. To ensure borrower’s right to fair valuation, RBI has set guidelines for valuation of collaterals. As per the SARFAESI Act, before selling the repossessed asset, the lender needs to get the valuation done from an approved valuer. In compliance with these guidelines, most banks have prescribed detailed criterion for empanelment of valuers and generally only these valuers are used. This ensures that the repossessed asset is not sold at any price – unilaterally determined by the bank.
3. Right to be Heard
You have a right to raise an objection to the repossession notice sent by the bank during the notice period. The authorized officer has got to reply within 7 days, informing you whether your objections were accepted or denied, giving valid reasons.
4. Right to be treated Politely
Banks are regulated entities. They cannot nor do they have the right to mistreat or harass you for defaulting. The bank has got to keep certain things in mind once they are communicating with you. A collection officer/bank agent has got to politely request to satisfy you at an area and time that’s convenient for you. The agent can meet you only from 7 AM to 7 PM. The collection agent is meant to treat you and your family with respect, without humiliating, harassing, or any usage of abusive language.