What can you do if you have defaulted on your personal loans? Experts explain

“A loan, though old, is not a gift" is an old Hungarian saying. This is especially apt in today’s digital age where even a minute delay is reported into the system and is remembered by lenders and others for a very, very long time.

Word to the wise – do not think of sweeping your loan (if defaulted) under the carpet and make sure that your lines of communication with your lender are prompt and concise.

“A settlement (of a loan) is when you negotiate with the lender to pay less than the outstanding balance,” explains Adhil Shetty, CEO, BankBazaar.

Essentially, this means you’re paying less than the amount originally agreed upon with the lender.

In such situations, the lenders report this to credit bureaus as a "settled" debt instead of a "paid in full" debt. Settled accounts imply a failure to fulfil the original credit agreement fully and indicate that the lender did not receive all the money they were owed.

So credit bureaus generally view a settlement negatively and as a result, a settlement can lower your credit score. That your loan is turning bad is something that needs to be factored in in today’s changing financial world.

“Personal loans have become increasingly popular among customers today as they eliminate the need to rely on others for financial support,” says Mayank Khera, Co-founder and Chief Operating Officer, Credgenics.

In today’s evolving world, the convenience of having anytime, anywhere access, minimal paperwork, and quick disbursement of loans has further fuelled the demand for personal loans.

Several banks, NBFCs, and FinTechs provide personal loans to meet customers' increasing financial requirements, including various short-term needs like purchases, medical emergencies, travel expenses, education, and weddings, thus catering to the appetite of India’s populace for a quick financial fix.

Today’s (financial) consumers must know the process when for whatever reason they cannot pay their personal loan.

When a payment is missed, lenders usually send reminders via SMS, email, or phone calls. These reminders start immediately after the due date.

If the borrower continues to miss payments, the lender will issue a formal notice of default, which often also outlines the consequences of continued non-payment and may be the last chance the borrower has to settle the dues without further action.

In the event, if the borrower is facing genuine financial difficulties, the lender may consider restructuring the loan. This restructuring of the loan can involve extending the loan tenor or providing a temporary payment holiday.

As a last resort, the lender might initiate legal proceedings against the borrower to recover the unpaid debt, leading to the seizure or auction of the borrower’s assets that were pledged as security or collateral. “Lenders usually look at legal action as a last resort and prefer to negotiate a settlement or restructured payment plan wherever possible,” say experts.

Most lenders provide a grace period of 30-90 days after the due date during which the borrower can make payments without the loan being marked as a default. However, lenders report the borrower’s payment status to credit bureaus throughout the collection process. “So any defaults and delays in payments will affect the borrower's credit score negatively for the long term,” cautions Shetty.

It is crucial for borrowers to understand their rights, seek legal advice if uncertain, and explore options such as negotiating a settlement. “Ignoring the situation makes it worse and proactive engagement is the key to minimising the consequences and addressing the issue effectively,” stresses Khera.

Defaulting on a loan results in several adverse consequences

Initially, your credit profile and credit score take a hit, making it harder to secure future loans on favourable terms.

Next, lenders may engage collection teams to pursue repayments, potentially leading to legal action. “Defaulting also incurs additional fees and interest, increasing the total borrowed amount. If the loan is secured, repossession or foreclosure of the collateral is possible,” cautions Khera.

Do consider that co-signers may face financial strains

“Open communication with the lender is crucial, as they may offer options like repayment plans or assistance programs. Despite the challenges, there are avenues for credit recovery, such as debt consolidation or credit counselling, to mitigate long-term effects,” advices Khera.

Manik Kumar Malakar is a personal finance writer.