Defaulted on Loans? Follow These Steps to Get out of a Debt Trap
Pune-based Vikas Manjekar, 29, would rather forget the dark days of January 2019, when he lost his job. Unfortunately, he couldn’t. At that time, he was repaying a personal loan of Rs 5 lakh, which he had taken a few months earlier, for his father’s medical treatment. To make matters worse, he had also borrowed Rs 10 lakh for his post-graduate education and was paying the equated monthly instalments (EMI) for the loan. From his monthly income of Rs 45,000, he was repaying Rs 22,000 in EMIs. He was the sole earning member in the family as his father was under medical care. “I used up my savings and investments in the first couple of months for my EMIs and then had to borrow from my friends and family members,” recalls Vikas.
Vikas’ situation is not unique. According to a recent survey by CreditMate among two lakh borrowers across all states, for 36 per cent of the people, a delay in salaries and for 29 per cent, a business downturn (mainly impacting self-employed) were the two main reasons for debt defaults. These were followed by medical emergency in the family, at 13 per cent, and loss of job, at 12 per cent. The survey results show that several borrowers are in a risky financial situation at present and are wondering about the consequences of defaults on loan.
Defaults come with consequences
A default simply means a borrower has not paid his EMI amount with interest to the concerned financial institution as per the loan agreement. As per the Reserve Bank of India (RBI) regulations, banks consider default on loan after 90 days are completed of non-payment from a borrower.
When Vikas defaulted, initially the financial institutions contacted him through email and mobile messages, asking him to repay. Vikas replied to these institution and said that he would repay immediately after he gets a job. However, in the last couple of months the financial institution’s officials turned aggressive and debt collectors were visiting his home once a month as well as calling quite often from different numbers and using strong language to repay the loans. “This is worsening my mental health condition and now I am unable to focus on finding new job,” says Vikas.
Aman Kapoor, Chief Engagement Officer at Credit Sudhaar says, “Defaulting on loans will have a deep impact on the credit score of the borrower. The person won’t be able to access credit from formal financial institutions; even if he/she manages to get a loan, the rate of interest will be high.”
Now, several employers run a credit check before hiring employees. So, defaulting on loans can even impact your job prospects. Radhika Shah, CEO and Director of Aarvi insurance brokers says, “Also, when you default on loans or credit card dues and decide to buy an insurance policy, the insurance company may reject your application.”
Effective October 1, banks charge a credit-risk premium over external benchmarks for calculating the effective interest rate on loans. Aparna Ramachandra, Founder Director of rectifycredit.com says, “This makes the credit score of borrowers an important factor in determining the interest rates on the reset date of the loans and banks may charge higher interest rates in case credit score deteriorates during the loan tenure due to default on credit card dues or other loans.”
Talk to your bank
During the tenure of the loan when you know that you’re about to default on loans due to any adverse circumstances, your best chance is to be proactive and contact your lending institution. Parijat Garg, credit scoring consultant says, “Explain the present conditions in detail to the lending institution. There is a possibility that your bank may restructure the existing loan by increasing the tenure and reduce the EMI burden or offer some other options.” This will allow you more breathing room to get back on track and help maintain your credit score. “However, such terms of negotiation vary from bank to bank on the basis of relationship between the borrower and lender,” says Wilfred Sigler, Director of Sales and Marketing, CRIF High Mark.
In September’19, Rahul Patel, 31, who is working in manufacturing company, received an email from the company that there will be salary cut by 15 per cent for all employees effective October’19. He was paying an EMI of Rs 10,000 for a car loan taken in May’19. He informed the lender about his financial condition. The bank understood his financial condition and agreed to charge only interest for six months on the outstanding car loan, with the condition that as and when he gets a new job (before six months), he should start repaying the regular EMI. In this financial arrangement, lending bank doesn’t mark your loan as a non-performing asset and your credit score is also not impacted. Says Ramachandra, “Always put such communications with your lender in writing.”
Stop or reduce usage of credit cards
If you lose your job or if there is salary cut initiated by your employer, stop or reduce using credit cards for day-to-day transactions. Kapoor cautions, “Regular use of credit cards with no income due to job loss or cut in income will lead to increase in credit card outstanding month-on-month. Carrying forward these outstanding amounts by paying only the minimum amount will lead to a vicious debt cycle.” Annually, you will pay an interest of 36 to 42 per cent per annum on the outstanding balance.
Sell your dud investments and policies to repay loans
If you have an endowment policy and an outstanding loan, you would be paying a higher rate of interest on the loan as compared to the return you earn on the endowment plan. “Then, it makes sense to surrender the endowment plan or take the loan against the endowment plan and pay-off the loan. You will save substantially on interest being paid for the loan,” says Abhishek Bondia, the co-founder and principal officer of SecureNow. In case you have non-performing mutual fund schemes or unit linked insurance plans (ULIPs) that consistently underperform benchmark indices, sell them and pay-off the loan. It is a wise decision when you have outstanding loans for three years and more.
You can also look at buying an insurance policy to cover your EMI payments in case of a job loss. For instance, Bajaj Allianz’s Loan Care takes care of up to three EMIs in case the policyholder’s employment is expressly terminated. However, do note that it will not come into picture if officially, the reason stated is voluntary resignation, which is generally the case in India. Some insurers also offer group covers that take on borrowers’ liabilities in case they default on repayments due to reasons beyond their control. These are usually offered through lenders, lending platforms and other institutions. Take, for instance, ICICI Lombard’s Group Secure Mind, which covers events like critical illness, job loss and accidental death or permanent disablement. In case of a job loss, the policy will take care of the borrower’s EMI payments during the policy period or till she regains employment, whichever is earlier. However, since this is a group cover, an individual cannot buy this product off the shelf.
In case you default on loans or foresee such a possibility, the first step is to work closely with your financial planner and find a solution. You should not take on too many loans and go overboard with credit cards.You could liquidate investments that are underperforming and reduce the loan burden. Build a contingency fund to include at least three months’ EMIs. Also, restrict use of credit cards to 20-30 per cent of your take-home pay.