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What is a Non-Performing Loan?

Mary McMahon
Updated May 16, 2024
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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.

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Mary McMahon
By Mary McMahon

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.

Discussion Comments
By JaneAir — On Sep 30, 2011

@JessicaLynn - Banks are a business, not a charity. It isn't their responsibility to "help" people who can't pay back their non-performing loans.

A lot of states now have programs to help people who are in danger of having their house foreclosed on. And there are some charities that can help too! These days, people really just need to look around and explore their options, and they can get some help.

I think this makes a lot more sense than expecting the banks to lose money just because people can't pay back the loans they committed to.

By JessicaLynn — On Sep 30, 2011

I really think banks need to try a little bit harder to work with people who possess the non-performing loan. As the article says, it's cheaper in the long run than trying to foreclose the house and sell it someone else.

If banks would work with people by lowering interest rate or deferring a few payments, I bet the rate of foreclosure would go down by a lot. With the way the economy is, a lot of people could uses extra help.

By surfNturf — On Sep 29, 2011

@Bhutan - Most of the banks have a lot of non performing assets in terms of real estate and are looking to auctions to liquidate their inventory. I bought a foreclosure this way and the bank really has nothing to lose because the bank has a reserve price for the property so if the bid is too low the bank can reject it.

They also have a chance to offer financing to investors that qualify and have the money to buy the properties in the first place so the bank can make money on that loan as well.

The banks have to be careful not to flood the market with all of the foreclosures at once because it will severely depress the real estate market even more. I know that banks have learned their lesson and are now offering loans to people that can actually afford the loan. Many of these non performing assests have destroyed many regional banks in my area.

By Bhutan — On Sep 29, 2011

I think that the banks have a lot of nonperforming loans on their books because of the high rates of foreclosures all over the country. I know here is South Florida we were severely affected and had one of the highest foreclosure rates in the country.

I remember during the real estate boom banks were offer no doc loans which were essentially no documentation loans which meant that the borrower agreed to a higher interest rate, but did not have to prove their income in order to get approved for a loan.

This was crazy. I read in an article that there was a lady that had a real salary of $40,000 a year that had multiple mortgages on several properties and had mortgages totaling $900,000. How can a person earning only $40,000 a year possibly be able to owe $900,000 in mortgages?

I think that the banks also wanted to make money during the real estate boom and anyone with a pulse could basically get a loan. This is why banks have come full circle and are now requiring standards like a good to excellent credit rating and fair down payment of at least 20% before they would consider giving out a loan.

Mary McMahon
Mary McMahon

Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a...

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