A non-performing loan is a loan which is either in default, or is about to be, with a reasonable expectation that the loan will enter default even though it has not technically defaulted yet. As a general rule, banks like to avoid non-performing loans, because there is a risk that they will not be able to recover the principal left on the loan, let alone the interest which has accrued. This type of loan is also sometimes known as a non-accrual loan or simply a doubtful loan.
The terms under which a loan can be described as non-performing vary. The basic rule of thumb is that if no payments on the interest or principal have been received for 90 days, it is a non-performing loan. If special arrangements have been made to refinance or delay payments and there is reasonable doubt that the debtor will be able to repay the loan, the loan can also be considered non-performing even if the 90 day period has not elapsed.
Once a loan has been classified as non-performing, the lender can start to take steps to recover the principal. In the case of a loan which has been backed by an asset, the asset can be seized. The classic example of this is a home foreclosure, in which the bank takes the home which backs a loan and sells it to another buyer to recover the amount of the non-performing loan which is still outstanding. Another example might be a car repossession, in which a non-performing car note is made good by taking the car back and selling it to another buyer.
Banks can also utilize collection services in an attempt to collect on a non-performing loan. The measures which can be taken by such services vary, depending on where they operate and the type of the loan. Sometimes, the bank may be willing to make arrangements with the borrower to put the loan into forbearance to to provide other assistive measures to help the borrower get back on track with repaying the loan, as this can be less costly than the steps needed to collect on the loan by other means.
Non-performing loans look bad on the bank's books. Banks want to be able to document a steady flow of incoming payments on outstanding loans. If the non-performing loan component of a bank's loan portfolio starts to climb too high, it can trigger concerns that the bank will not be able to remain solvent.
Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a SmartCapitalMind researcher and writer. Mary has a liberal arts degree from Goddard College and spends her free time reading, cooking, and exploring the great outdoors.