With online loan processes in place, it has shortened the process and the time-span it takes for a loan to get approved. Banks, small finance companies, non-banking financial corporations (NBFCs) and online lenders have made it easier than ever to get loans. Many first-time borrowers are not sure on how repayment works and what are the penalties levied if the borrower does not make the EMI payments on time.
Anu, a home loan borrower had an income of Rs.12 lakh p.a as an architect. She had recently received a salary raise and wanted to fulfill her dream of owning a house. Since she had a credit score of 800 points and saved up a down payment of Rs.8 lakhs, she wanted to opt for a housing loan. Her home loan of Rs.40 lakhs was approved by her bank.
Anu was paying her dues on time until family disputes hit her out of the blue. It hit her personal life and finances hard. Since this was unpredictable, she was not prepared for this and it affected her payment of EMI. Here’s what she went through with regards to her home loan repayment process and how she found a way to work things out.
Missed EMIs are classified into two categories:
- Major Defaults
- Minor Defaults
What does the term ‘default’ mean in loan?
When a loan borrower fails to repay a debt (including principal and its interest on a security/loan) it is termed as default. A default can occur when the borrower is unable repay on time, misses payment, or stop making repayments altogether. Any individual, joint borrowers, businesses or a body that delays or fails to repay an EMI is said to have defaulted on the loan.
When a borrower does not pay his/her EMI for 90 days or more, it is a major default. This default is recorded in CIBIL report and the score drops. Also, this default impacts any loans that one may apply for in future as it is marked as Non-Performing Asset (NPA).
When a borrower does not make an EMI payment within 90 days or less, it is termed as a minor default. Borrowers can recover from minor default by taking timely action.
What happens when you miss loan EMI?
Penalty of late fee
If you miss only one EMI, bank charges 1%-2% of the EMI as penalty. Penalty amount is to be paid with the due EMI and the next month’s EMI in the immediate next payment cycle.
Entry in your credit report
Every penalty levied for a loan you take is recorded in your credit report. Since CIBIL report is to determinethe financial credit-worthiness of an individual, penalties are black marks. This not only reduces your credit score, but also restricts your future loan applications from being approved. Even if your future loans are sanctioned, you will be charged a high rate of interest due to the black marks.
Pulls down your CIBIL score
It is a well-known fact that defaulting EMI result in lowering CIBIL score. Even if you miss a single EMI payment, it reduces your credit score by 50-70 points. You don’t want that, do you?
Face-to-face recovery attempts
When one’s loan is classified as NPA due to penalty is when banks/lending institutions resort to recovery agents. The job of the recovery agent is to recover the dues from the borrower either from borrower’s residence or workplace. Most of the lenders send a 60-day notice before classifying the loan as NPA. Face-to-face interaction with the recovery agents is both stressful and embarrassing.
Lose eligibility for balance transfer
Most of the lenders have a rule that if one misses an EMI payment for three times or more, the new lenders you want to switch to will not consider your loan application. This is because the penalties put you in the high-risk category of not being able to recover dues.
How much is late fee penalty?
It is a common practice for most of the banks to charge 1%-2% of the EMI amount as a late fee penalty. Exact amount would be mentioned in the offer letter that is handed over to the borrower at the time of loan sanction confirmation. Rough calculation can be sought while getting to know the loan amount that the bank is willing to lend you.
Does the late fee penalty carry their own compound interest if EMI is defaulted for more than one month?
Other terms for late fee penalty are incidental charge, missed EMI charge. Incidental charges vary from bank to bank. Some banks charge on the overdue principal amount per annum, whereas others charge a percentage per month that is compounded monthly. Simple answer is – yes, incidental charge compounds if left unpaid.
The compound interest not only varies from one bank to another, but also from one loan plan to another. So concerned bank official is the right person to get the correct information regarding this.
How to avoid loan defaults?
Now that Anu had faced consequences of defaulting loan, she had to come up with a solution soon so that the minor penalty can be corrected at the earliest and the interest on incidental charge does not compound.
Request lender to pause EMI temporarily
Most banks accept the request to pause EMI temporarily when the reason is loss of income. When people face pay cut or job loss, the maximum time period that the banks waive off EMI is for 3-6 months. Waiver means you don’t have to pay EMI for the said months as your loan cycle is paused and you can continue to pay EMI once you get back on your feet.
Make part payments
Since Anu faced family crisis and not job loss, she could not request for a pause in her loan cycle. Instead, she opted for making part payments of EMI. She payed part of loan/half the EMI amount instead of skipping the payment of EMI altogether.
The term ‘Part payment’ is also used when a borrower wants to repay a large sum of money to the lender when he/she has surplus funds. This eases the financial burden of the borrower.
Request for lower EMI
In case the borrower is aware of the possibility that he will miss making his upcoming EMI payment, he can approach the bank and request them to lower the EMI amount. Banks honor this request by extending the decided loan tenure so that the EMI amounts can be compensated, or, by converting an unsecured loan to a secure loan.
Borrower can also request the bank to convert his/her unsecured loan to a secured loan as the advantage of this is immense. The interest rate on secure loan is less when compared to unsecured loans. Once the loan is converted, the EMI will also reduce since the interest payable reduces on the principal.
With myriad options available in the market, it may be tempting to get a loan and fulfill all our wishes. But we should also be aware of the fact that any loan that is taken needs to be repaid to the lender with due interest and within a stipulated period of time. Failure to do so will lead to outrageous consequences that affect long-term financial situation of an individual. Therefore, make sure you get a loan only when you are sure financially to be able to pay it back to the lender without any issues.