What should we do when we default on our loans?

I have a friend  Amar (name changed to protect privacy) who took a loan in 2013, after that he got married, his wife was housewife and suddenly there was a large medical expenses and he lost his job at that time due to which he defaulted on his loan payments. What recourse does he have? The bank has now started harassing him.' 

Anyone of us can be in same situation like Amar’s. Imagine yourself in a situation where you have taken a loan, say a home loan, and you lose your job and have difficulty getting another job at the same salary. Or for whatever reason, are unable to make the regular EMI payments. Perhaps you don't even have insurance on your home loan amount.

The stressful nature of this situation can lead people to panic, or worse. 

But all is not lost! It is very much possible, with some discipline, to rectify the situation. In this post we will lay out some simple steps that can be taken in this kind of situation.

Step 1: Be Calm and don’t get panicked

For you it may be first time but this is not a rare situation. Banks have many customers who default on payments all the time.

So just relax you are not the only one. There's no need to feel like you have a great weight on your shoulders and you have to bear it by yourself. In fact, your bank will be the first entity willing to help you. Defaulting on your loan, even if it is a home loan, is not the end of the road. 

Step 2: Get your documents in Order and connect with the Lender

You should have all the documents at one place. If not that first create a file containing all your past EMI payment details, notices sent to you by the bank if any, details of the loan i.e. date of taking the loan, tenure, interest rate, EMI amount and so forth. Keep them handy when you talk to your lender. Tell your lender the genuine reason(s) that have rendered you unable to pay the EMIs, tell them that you would like to pay your loan back as soon as you can, and ask them what their options are.

Once you contact with the bank with the necessary details, you will get a call from your bank and can set up a meeting to calmly and rationally discuss your options. 

Step 3: Contemplate Your Options, in Dialogue with Your Lender

Can the bank repossess your asset i.e. your car or your home? Legally, yes they can. But there are a couple of reasons why you don't have to necessarily worry about this. 

Firstly, the repossession of assets procedure in India (and in fact elsewhere in the world as well) is very lengthy and there are steps along the way where you and the bank can work together to come to a satisfactory deal.

If you are a regular payer until now, the bank understands that you are a genuine borrower, and will take this into consideration when working together with you to find a mutually feasible solution. 'Genuine intent' to repay is the single largest thing that will work in your favour. Be sure to make it very clear to your bank that you do intend to repay and would like to work together to find a solution.
Genuine reasons that banks understand are loss of a job, illness, or an accident that may render you unable to work. You might also have multiple loans, and find yourself in too much debt to handle. 

Secondly, the banks are in lending business and are not interested to repossess your assets, it wants you to pay the money owed, or at least most or part of it. If you default, the bank's NPA ratio (Non-Performing Assets) goes up. This reflects badly on the bank. Also, they lose out on the money you would have paid them. So the bank will much prefer to cut you a deal. 

Here are what your options will likely be: 

a.      Refinancing the existing loans

If your problem is one very high monthly EMI, due to increase in overall interest rates, or an increase in your personal commitments to yourself, your loved ones, or any other matter personal to you that reduces your bank balance, or a combination of these factors and others, then what the bank can do is to restructure your loan. 

If you are currently paying Rs. 25,000 per month for 20 years, and this is too high, the bank might offer you an EMI less than to say Rs. 20,000 per month, for a little more than 20 years. So your EMI goes down, giving you some breathing room and the bank doesn't lose money because it will simply make it up from you over a longer period of time. Everybody wins on some level. 

However you should keep in mind that the payments you now make will eventually cost you more in terms of total money repaid, but if breathing room is what you need, this will provide it. However the extension in tenure will be small, so the change in your EMIs will also be small. Also, as a next step, the bank can opt for foreclosure by selling off the collaterals stated when you applied for the loan, by auction, with your co-operation.

Refinancing can be done for many situations. 

It is also the go-to option for people who find that their bank is not reducing floating interest rates in line with other banks. You can approach your bank to reduce rates, or you will shift to a more other lender who is willing to offer at lower rates. For credit card debt, you can also opt for balance transfer by shifting your existing debt onto a new card with a 0% interest rate for 6 months, and paying off as much as you can within these 6 months, however before transferring you should be clear about the terms and conditions. 

b.      Deferring Your current EMIs

There could be a different problem that currently due to loss of job or some reasons you can’t pay at all and are hopeful that once you get the job and things becomes normal you will be able to pay in normal way.  In this type of situation you can approach your bank for deferral of your payments. The bank can grant relief, giving you a window of opportunity to calmly seek ways to increase your cash flows. 

Once the time is over, your EMIs will restart (on either the same terms or your new negotiated terms), but will include late payment penalties, known as Delayed Payment Charges. These charges are applicable for payments made after their due date. In case some of your post-dated cheques (PDCs) have bounced due to insufficient funds, you will also be subject to cheque bounce charges.

c.      One time Settlements

One time settlement may not be feasible for a big loan like home loans, but it can work for a personal loan, credit card outstanding, or a car loan. On a case to case basis, banks are sometimes willing to go for one time or lump sum settlements of outstanding dues. They will waive some of the charges or some of the amount and charges, and you can pay the rest as a loan settlement. However, this will impact your credit score greatly in negative way. Getting a loan in the future, if you want one, will become either very difficult or very expensive, or both.

What happens if you still can't pay? 

Finally if you have no way out to pay off your dues, the lender will seek repossession of the asset. The asset will be auctioned off within 15 days (for a movable asset like a car) or 30 days (for an immovable asset such as a home). During this period, you still have the option of buying back your own property provided the funds are available to you.

At no time during the process will the lender not give you the option to pay, in bits and pieces or via a reduced lump sum, and maintain possession of your asset. 

Conclusion

As we understand, the best solution is that we should pay our dues on time and do not get into this situation in the first place. But once you are in it, remember that panicking will get you nowhere and your time would be better spent in dialogue with your bank, coming up with a feasible solution together. You can also contact credit counselling centres for guidance. 

One of the main tenets of financial planning is safety. This is done by way of a contingency fund. Remember, if you have EMIs, to include them in your contingency fund and have at least 6 months to 2 years of expenses set aside in a safe liquid fund, for use in case of emergency situations.

Also, we should plan our finances properly based on our future goals i..e buying homes, Retirement Planning, Kids education and marriage etc. For this the plan should be made through an experienced Financial Advisors keeping all the aspects and contingencies.