When immediate cash is not accessible, people take out loans to cover various needs such as buying a home or automobile, pursuing education, or dealing with emergencies. When principle or interest payments are not made for more than 90 days, the loan is termed defaulted. Borrowers default on loans for a variety of reasons.
Based on the 90-day and 120-day delinquency norms, a loan account qualifies as a Non-Performing Asset (NPA). In a recent announcement, the Reserve Bank of India (RBI) stated that the formalisation of business through registration under GST has negatively impacted the cash flows of smaller firms during the transition period, resulting in challenges in meeting their repayment commitments to banks and NBFCs.
Impact of an EMI default
- Adverse impact on Credit Score
The bank will report a default to the credit bureaus which will reduce your credit score and impact your credit history negatively.
- Higher Interest
The bank may charge a higher interest rate on your loan, if you default on your EMI several times, as you may be considered a risky borrower.
- Reduces Future Borrowing Capacity
As a reduced credit score lowers a borrower’s creditworthiness, it impacts overall financial health and credit eligibility and approval chances in the near future.
- Losing possession of Pledged Collateral/Asset
In the case of secured loans, repeatedly delaying EMI payment and eventually defaulting on the loan can lead to loss of pledged asset/collateral. Lenders have the right to take possession and even auction your asset/pledged collateral upon default to recover the outstanding dues.
- Lowers chances of Loan Balance Transfer
Another financial implication of loan default is that irregular repayment history and delays can hamper the borrower’s chances of finding a balance transfer facility when required.
Other Serious Repercussions:
- Today, many companies do a check of potential candidates’ credit history before hiring them. A negative credit report could hamper your chances of landing your dream job
- You may find it tougher to get a loan or you may be charged a higher rate of interest.
Guide To Avoid EMI Default
1. Use your Contingency Fund
You do not know when a disaster strikes, and have all your carefully laid plans going awry. To meet the unexpected emergency, you should have a contingency plan. Why not set aside at least 3 months EMI amount and create a contingency fund to avoid EMI defaulting. You may also keep aside a certain amount of money that can take care of your monthly expenses, including the EMI payments.
The amount you save should ideally be 3 or 6 times of your monthly income. Nevertheless, there is no limit; you can even go for a higher amount to create an emergency fund. This can be put in a fixed deposit or in a savings account.
2. Keep Sufficient Balance
Your bank account should have sufficient balance to ensure that you do not run the risk of defaulting on a loan. You run the risk of being termed a defaulter if you do not pay within 90 days of a due date, and I ideally advise businesses to keep three months of EMI as reserves to tackle loan repayments. Businesses can be cyclical or an unforeseen event may cause disruptions. In such cases it is always advisable to have enough headroom to ensure your loan repayments are not missed.
3. Raise Money through a Loan against Investment
If your contingency fund is exhausted, and you need to look for other ways to meet your expenses, as well as repaying your loans, then, it is advisable to take loan against your investments or assets like gold, insurance policy or fixed deposits. These loans can be used to repay your home loan EMIs, for they come for a lower interest and can be paid back later.
4. Rescheduling your Debt
If you feel the amount of monthly outgo is the real problem behind your repayment, you can negotiate with your lender to reschedule your loan. In such cases, your interest rates are revised and the loan tenure can be extended. This would mean the amount you pay to your lender every month will come down and things should get more manageable. Debt rescheduling does get reported to credit agencies so this would be a negative on your credit report.
5. Use your EPF Advance Withdrawals
If you do not have any other option to meet financial contingencies, then you can think of advance withdrawals from your employee provident fund account. The EPF advance amount withdrawals are allowed for various purposes such as education, purchase of property, marriage, home loan repayment, and so on. As for the home loan repayment, you should have completed a minimum of 10 years of employment to withdraw a maximum amount from your EPF account, which is 36 times of your salary or wages.
6. Live and borrow within your means
This may seem like an oversimplification, but it is very important to have a tight grip on your costs if you have debt to service. There is no getting away from the monthly payments till the debt is paid in full, so every business needs to be judicious about their expenses. Similarly, it is extremely important to borrow only hat you need. Debt or taking a loan should not be easy money for a business. It comes with interest and a repayment scheduled attached with it.
7. Find a Solution by Contacting Your Bank
Once you have exhausted all your options or you do not know how to prevent being an EMI default, you can discuss the situation with your bank or lender. Where your case is genuine, you can convince the bank to give you some options. A bank may offer you a grace period on evaluating your credit history. It is a moratorium for a short period; where you are allowed time to recover from your financial difficulty.
What to do if you have Defaulted
- Defer paying EMI: If you have defaulted on your EMI get in touch with your bank and speak to your loan officer. If it is a genuine reason, say you had a medical emergency in your family and needed to divert funds towards that, the bank may agree and allow you to pay the EMI in the following month. But make sure you pay both months’ EMIs without delay. The bank may charge you a late payment fee.
- Tenure Extension: If it is a more long-term reason, say you had a pay cut or lost your job, again speak to your bank and try to restructure the loan. Request the bank to the EMI amount by extending the tenure. This will give you some relief and you will be on track to repaying your EMIs from the following month.
- Interest Payment Flexibility: In some cases, depending on your track record and relationship with the bank, you could request that you be allowed to pay only the interest for a couple of months till your financial stress is resolved. With the condition that your payment will be on track after this. You may be asked to give the fixed time for when you want the relaxation. Remember, this is not common and it is the discretion of the bank to agree to this condition. And ensure you communicate with the bank in writing your intention to repay and restart your EMIs, with the fixed time.
- Loan Settlement: If none of these is possible speak to your bank to settle your loan. This means that you agree to repay a part of the loan amount and the bank considers it as a ‘settled’ loan. While the first four measures will keep your credit score intact, settling your loan will have a negative impact on your credit score and history. A loan that is settled is always viewed more negatively than a loan that is repaid in full.