Retail lenders have faced several challenges due to Covid-19. On the one hand, the demand for small loans has increased as lockdowns hit livelihoods, while on the other hand, the rate of recovery has slowed. As a result, the increase in delinquencies on loans has lowered the credit ratings of borrowers.
“The creamy layer or low-risk borrowers saw their credit scores drop by about 5% from March 2020 to March 2021,” said Subhrangshu Chattopadhyay, national sales manager, CRIF High Mark, a credit bureau approved by the RBI. A credit score shows your creditworthiness. This is why lenders have tightened their credit policies. Most only lend to existing customers with a good credit history. A CIBIL score of 750 or more is ideal for obtaining 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 interest rate.
While the upward trend in defaults has affected lenders, for borrowers too, default has serious consequences. First, it can affect their ability to qualify for a loan in the future. And second, even if such a person is able to take out a loan, it will be at much higher rates. A default, if declared “voluntary”, can also lead to criminal prosecution. Here is the truth about the consequences of default on borrowers.
Changing trend: small is big
Travel, marriage, home improvement, down payment for a house, used vehicle, raising children, and paying off higher interest rate loans were some of the main reasons people borrowed before Covid-19. After the Covid-19 epidemic, the trend shifted towards consumer-related and essential spending. “Travel-related borrowing has slowed. People are now borrowing to renovate their homes, pay off high-interest debts and down payments, ”says Gaurav Chopra, founder of IndiaLends, an online loan aggregator.
According to the RBI Financial Stability Report, the industrial sector’s share of bank lending has declined in recent years, while that of personal loans has increased. In 2014, personal loans represented 16.2% of overall credit. This figure rose to 26.3% in 2021. The share of small loans is also increasing. A report from TransUnion CIBIL and Google shows a 23-fold increase 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 was a 23% increase in the value of credit card transactions at ATMs and point-of-sale terminals from March 2020 through June of this year, according to RBI data.
Adhil Shetty, CEO and co-founder of BankBazaar.com, says that with the relaxation of KYC standards, it has become easier for credit card issuers to serve customers in Tier II and III cities. “As a result, demand for non-metro credit cards continues to peak. The contribution of non-metros in total requests rose to 35% in FY21, compared to 24.8% in FY20, ”he adds.
Retail Postcode Increase
The flip side of the growing popularity of retail loans has been an increase in non-performing assets (NPAs) at most of the major banks. ICICI Bank, the country’s second-largest private sector lender, added Rs 6,773 crore of gross NPA to retail and merchant banking portfolios in the first quarter of FY22, up from Rs 4,355 crore in the fourth quarter of the FY21. Axis Bank reported gross slippages of Rs 6,518 crore compared to Rs 5,285 crore in the fourth quarter of the previous year. “Axis’ slippages have been dominated by retail lending,” says a report from ICICI Securities.
CRIF High Mark credit bureau agrees delinquencies on loans increased during Covid. Lending platforms have become cautious as a result. A recent report from PwC Equifax indicates that more than 70 percent of credit managers have changed their standards, especially for those with bad credit histories, in order to maintain asset quality. Online lenders reject 45-50% of loan applications after the pandemic. This is mainly because they now take into account additional parameters for underwriting such as recession, unemployment and insurance losses.
As people become more comfortable with taking on debt and new lenders proliferate online and offline, borrowers and lenders will need to act responsibly to avoid problems down the road. Lenders, says Chopra of IndiaLends, have already become cautious about underwriting. Likewise, borrowers should be responsible and do their best to repay the loan. Otherwise, there can be serious consequences.
Consequences of default
Credit history takes a hit: Each month, or whenever the loan payment is due, the lender informs the credit bureau of the status of the payment. Although it can ignore a delay of a few days, any late payment beyond 30 days is reported to the credit bureau. This can have an impact on the person’s credit profile. However, a 30-60 day delay will permanently stain a borrower’s credit history, while a delay of more than 60 days can severely damage the credit rating.
A low credit score reduces a person’s ability to borrow in the future. “Today you may have borrowed to buy a phone or a two-wheeler, but next time you will most likely have a bigger need or an emergency. You may be denied the loan because of a bad credit rating, ”says Chopra of IndiaLends.
Online lending platforms that provide small loans are even more conservative. Even a single day late, according to Bhavin Patel, co-founder and CEO of LenDenClub, can put the borrower on the default list. “A defaulter will no longer be able to receive a loan in the future, unless they pay off the old loan on our platform.”
Higher interest rate: Lenders today associate the interest rate with your credit score. A bad credit score will increase your borrowing costs and reduce your savings in the long run. Shetty from BankBazaar.com explains. “On a mortgage of Rs 50 lakh for 20 years at a low interest rate of 6.8%, the total interest paid would be Rs 41.60 lakh. But, if your credit score was poor and you were to pay 8.5% on the same loan, your interest payment would be Rs 54.13 lakh. So you will pay almost Rs 12.53 lakh more.
The difference will be narrower in categories of secured loans such as home loans — 10-200 basis points in most cases. For example, two very large real estate 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 larger in unsecured categories such as personal loans. “A private bank values personal loans from 10.5% to 19%.” You can save this money for other life goals, like investing for retirement or financing your child’s education.
Fintech lending platforms have a head start. Their algorithms adjust interest rates based on the current default rate to minimize the impact on their portfolio. For example, in the first quarter of 2020, IndiaLends increased its interest rates on loans by 0.8% as the default rate on its platform increased by a percentage point.
Legal implications: Failure to pay is a civil offense. However, the lender may try to cash blank checks taken from the borrower, explains Shetty of BankBazaar.com. It is a criminal offense to refuse to honor a check due to lack of funds.
In the normal course, if a client does not pay within 90 days, the file is sent for the initiation of legal proceedings. The lender can bring an action against the borrower under section 138 of the Negotiable Instruments Act, 1881, after 180 days of default. If the borrower does not pay when he has the capacity, the RBI can declare him “intentional in default”. However, if he is unable to pay for a valid reason, he can make a deal with the lender that gives him more leeway to pay.
However, most of the fintech lenders who provide small loans have not faced such cases until now. “These are tough and high level stages. We have not yet been confronted with such a case. In the majority of cases, when the case comes to court, the client offers to settle the loan, ”says Bhavin Patel of LenDenClub.
Auction of goods: In secured loans like a home loan, the lender has the right to auction the property after the legal process. Likewise, in the event of a car loan, the lender can seize the vehicle. Lenders can also auction the borrower’s gold if they fail to repay the loan taken against the yellow metal. However, he must provide the borrower with 30 days’ notice before taking such action.
Job Loss : Most companies do not hire people involved in criminal activity. For some managerial positions, especially in industries such as financial services, companies check the candidate’s credit history to see if they 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 also have a negative impact on the defaulter’s passport.
Do you have to borrow to repay another loan?
“If it saves money, then it sure does,” says Chopra. A credit card, for example, can have a very high interest rate of around 3.5% per month or 42% per year. “Taking a personal loan, which starts at 10-12 percent, to pay off credit card debt would be a good strategy,” he says. Most people can get a personal loan at an annual interest rate of 14-15%.
“Likewise, if the intention is to refinance a home loan because it saves the borrower thousands of rupees over the life of the loan, that’s a good idea,” says Shetty of BankBazaar. But if the person’s credit habits remain bad, refinancing may not help, he adds.
The second loan should be used to pay off the existing high interest loans. It shouldn’t become an additional debt burden, experts say. Credit must be used wisely. The widely recommended rule is to use 30 percent of your credit limit. “The more you use your credit limit, the more impact it will have on your score,” says Shetty.
First of all, 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 emails to the borrower in the event of late payment. If the loan became an NPA because the payment is 90 days past due, the bank or financial institution must give 60 days notice for the refund of contributions.
The defaulter is also entitled to receive the difference earned by the lender (by selling the foreclosed asset) in addition to what is owed, Shetty says.
The defaulter will also be entitled to due process which may involve a moratorium, restructuring or even a single settlement.