Retail lenders have been facing several challenges due to Covid-19. On the one hand, the demand for small loans has surged as lockdowns hit livelihoods, while on the other hand, the recovery rate has slowed. Consequently, the rise in loan delinquencies has lowered credit scores of borrowers.
“The creamy layer or lowrisk borrowers have seen around 5 per cent fall in their credit score from March 2020 to March 2021,” says Subhrangshu Chattopadhyay, National Sales Head, CRIF High Mark, an RBI-approved credit bureau. A credit score shows your creditworthiness. That is why lenders have tightened their credit policies. Most are lending only to existing customers with good credit history. A CIBIL score of 750 or above is ideal for availing loans. If your score is below 750, it will be difficult for you to get loans from banks and NBFCs. If it is close to 750, you will get loans, but at a higher rate of interest.
While the trend of rising loan defaults has affected the lenders, for the borrowers, too, a default has serious consequences. One, it may dent his or her ability to avail a loan in the future. And two, even if such a person is able to take a loan, it will be at much higher rates. A default, if declared ‘wilful’, can also lead to criminal proceedings. Here’s the lowdown on consequences of loan default for borrowers.
Changing Trend: Small is Big
Travel, wedding, home renovation, down payment for a house, second-hand vehicle, children’s education and repayment of higher interest rate loans were some of the major reasons people were borrowing pre-Covid-19. After the outbreak of Covid-19, the trend shifted to consumption-related and essential expenses. “Travel related borrowings have slowed down. People are now borrowing for home renovation, repaying high interest rate debt and home down payment,” says Gaurav Chopra, Founder, IndiaLends, an online lending aggregator.
According to RBI’s Financial Stability Report, the share of the industrial sector in bank credit has declined in recent years, whereas that of personal loans has gone up. In 2014, personal loans accounted for 16.2 per cent of overall credit. This rose to 26.3 per cent in 2021. The share of smaller loans is also rising. A report by TransUnion CIBIL and Google shows a 23 times rise in loans up to Rs 25,000 between 2017 and 2020. The share of ‘
The trend is also reflected in bank credit card numbers. There has been a 23 per cent rise in value of transactions through credit cards at ATMs and point-of-sales terminals from March 2020 to June this year, according to RBI data.
Adhil Shetty, CEO & Co-Founder, BankBazaar.com, says thanks to relaxations around KYC norms, it has become easier for credit card issuers to service customers in TierII and Tier-III cities. “Consequently, the demand for credit cards from non-metros continues to peak. The contribution of non-metros in total applications rose to 35 per cent in FY21, up from 24.8 per cent in FY20,” he adds.
Retail NPAs Surge
The flip side of the increasing popularity of retail loans has been a rise in non-performing assets (NPAs) at most big banks. ICICI Bank, the country’s second-largest private sector lender, added Rs 6,773 crore gross NPAs from retail and business banking portfolios in the first quarter of FY22 as compared to Rs 4,355 crore in the fourth quarter of FY21. Axis Bank reported Rs 6,518 crore gross slippages compared to Rs 5,285 crore in the fourth quarter of the previous year. “Axis’s slippages were dominated by retail loans,” says a report by ICICI Securities.
Credit Bureau CRIF High Mark agrees that loan delinquencies have risen during Covid. The lending platforms have become cautious as a result of this. A recent PwC Equifax report says over 70 per cent credit managers have altered their standards, particularly for those with poor credit history, in order to maintain asset quality. Online lenders are rejecting 45-50 per cent loan applications after the pandemic. This is primarily because they are now factoring in additional parameters for underwriting such as recession, unemployment and insurance losses.
As people become more comfortable in taking on debt, and new lenders mushroom online as well as offline, both borrowers and lenders will have to act responsibly to avoid problems later. The lenders, says Chopra of IndiaLends, have already become cautious in underwriting. Similarly, borrowers should be responsible and do their best to repay the loan. Else, there can be serious consequences.
Consequences of Default
Credit history takes a hit: Every month, or whenever the loan instalment is due, the lender notifies the credit bureau about the payment status. While it may ignore a delay of a few days, any payment that is late beyond 30 days is reported to the credit bureau. This may have some impact on the person’s credit profile. However, a delay of 30-60 days will definitely stain the borrower’s credit history, while a delay of more than 60 days can severely damage the credit score.
A low credit score reduces a person’s ability to borrow in the future. “Today, you might have borrowed to buy a phone or a two-wheeler, but the next time, you will most probably have a bigger need or an emergency. You may be denied the loan due to the spoiled credit score,” says Chopra of IndiaLends.
Online lending platforms that give small loans are even more conservative. Even a single day’s delay, says Bhavin Patel, Co-Founder and CEO of LenDenClub, can land the borrower in the list of defaulters. “A defaulter will not be able to avail any loan in future, unless s/he repays the older loan on our platform.”
Higher interest rate: Lenders today link the rate of interest to your credit score. A bad credit score will increase your borrowing costs and reduce long-term savings. Shetty of BankBazaar.com explains. “On a home loan of Rs 50 lakh for 20 years at a low interest rate of 6.8 per cent, the total interest paid would be Rs 41.60 lakh. But, if your credit score was poor and you had to pay 8.5 per cent on the same loan, your interest payment would be Rs 54.13 lakh. Thus, you’ll pay nearly Rs 12.53 lakh more.”
The difference will be narrower in secured lending categories such as home loans—10-200 basis points in most cases. For example, two very large home financiers have a difference of 70 basis points and 125 basis points, respectively, between their lowest and highest rates, says Shetty. The difference can be much wider in unsecured categories such as personal loans. “A private bank prices personal loans from 10.5 per cent to 19 per cent.” You can save this money for other life goals such as investing for retirement or financing your child’s education.
Fintech lending platforms are a step ahead. Their algorithms adjust interest rates as per the ongoing default rate to minimise the impact on their portfolio. For instance, in the first quarter of 2020, IndiaLends increased its interest rates on loans by 0.8 per cent as the default rate on its platform rose by one percentage point.
Legal Implications: Loan defaults are a civil offence. However, the lender may try to encash blank cheques taken from the borrower, says Shetty of BankBazaar.com. Dishonouring of a cheque due to lack of funds is a criminal offence.
In normal course, if a customer does not pay till 90 days, the case is forwarded for initiation of legal proceedings. The lender may file a case against the borrower under Section 138 of the Negotiable Instruments Act, 1881, after 180 days of default. If the borrower does not pay despite having the capacity to do so, the RBI can declare him a ‘wilful defaulter’. However, if he is not able to pay for a genuine reason, he may reach an agreement with the lender that grants him or her more leeway to pay up.
Most fintech lenders who disburse small-sized loans have, however, not faced such instances till date. “These are harsh and high-level steps. We have till date not faced any such case. In a majority of the cases, as the matter reaches the court, the customer offers to settle the loan,” says Bhavin Patel of LenDenClub.
Auction of property: In secured loans like a home loan, the lender has the right to auction the property after the legal process. Similarly, in case of automobile loans, the lender may seize the vehicle. Lenders can also auction the borrower’s gold if s/he fails to repay the loan taken against the yellow metal. However, it has to provide the borrower a 30-day notice before taking such a step.
Employment loss: Most companies do not hire people involved in criminal activities. For certain senior positions, especially in industries such as financial services, companies check the candidate’s credit history to know if he or she can be trusted. “A bad credit history will make it difficult for a defaulter to get a good job,” says Chopra of IndiaLends. A criminal case will have a negative impact on the defaulter’s passport as well.
Should you Borrow to Repay Another Loan?
“If it saves money, then definitely,” says Chopra. A credit card, for instance, can have a very high interest rate of around 3.5 per cent a month or 42 per cent annually. “Taking a personal loan, which starts at 10-12 per cent, to repay the credit card debt would be a good strategy,” he says. Most people can get a personal loan at 14-15 per cent annual interest rate.
“Similarly, if the intent is to refinance a home loan because it saves the borrower lakhs of rupees over the loan tenure, it’s a good idea,” says Shetty of BankBazaar. But if the person’s credit habits remain bad, the refinancing may not help, he adds.
The second loan should be used to repay existing high interest loans. It should not become an additional debt burden, say experts. Credit needs to be used wisely. The widely recommended rule is to utilise 30 per cent of your credit limit. “The more you use your credit limit, the bigger impact it will have on your score,” says Shetty.
Foremost, borrowers have the right to be treated fairly and politely. “No lender can harass or intimidate borrowers,” says Shetty. Lenders are supposed to send notices, messages and e-mails to the borrower in case of late payment. If the loan has become an NPA as the payment has become overdue for 90 days, the bank or the financial institution has to issue a 60-day notice for repayment of dues.
The defaulter is also entitled to receive the difference earned by the lender (by selling the seized asset) over and above what is due, says Shetty.
The defaulter shall also be allowed the right to a due process which can involve moratorium, restructuring or even a one-time settlement.
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