What happens if a personal loan is not paid? Is there a punishment for nonpayment of a personal loan? Will the defaulter go to jail straight away? There will be hooliganism displayed at the defaulter’s front door by the Banks? What are the bank loan recovery rules?
Suggested Reading: What is a Bad Bank?
A person who is under stress due to non-repayment of a loan, face further nightmares answering these question. Defaulting on loan payments triggers fear. No doubt. But it must also be remembered that there are rights of a loan defaulter as well. Banks (lenders) cannot start arm-twisting the defaulter.
Points to remember:
- Why a loan defaulter needs protection: Because there may be a ‘genuine problem’, due to which one is defaulting on the loan. In a court of law, genuine reasons are given due weightage. It is true that banks will not allow their money to be let go easily. A due course of action will take place. But if one is unable to pay a personal loan EMI (say), this does not make him/her a criminal. Read more about What to do when loan EMI is very high.
- Loan defaulter will not go to jail: Defaulting on a loan is a civil dispute. Criminal charges cannot be put on a person for loan default. It means, the police just cannot make arrests. Hence, a genuine person, unable to pay back the EMI, must not become hopeless. There are rules which will help the defaulter to negotiate with his/her lender.
In case you think that your bank is not behaving properly, you can file your complaint with ‘The Banking Ombudsman‘. Read more about it here.
But it must be remembered that these rules are made for those people who, due to genuine problems, are not able to pay their due EMI. These rules are not for careless, escapists, wilful defaulters, and non-law-abiding people.
What a genuine person must know about the consequences of loan default?
Types of Loan Defaulters
There are three types of people who default on loans
- Careless people: These people are called careless because they took excess loan. They did not analyse their income/expense balance before taking loan. Such people realise their mistakes only after they start paying the EMI. They just cannot afford the EMI expense. Hence the default. Read more about why to become debt free.
- Genuine people: These are people who are facing genuine problems. They are people who paid all past EMI’s on schedule. But due to a genuine issue, are not able to pay-back the loan any more. Read more about should you pay home loan early.
- Over-smart people: These are people who try to game the banks. They think that they can mislead the bank by giving fake-reasons for non-payment. These people are also commonly referred as ‘wilful defaulters’. These people ultimately gets booked u/s 420 of IPC and may be jailed.
All loan defaulters must first realise that, “loan payment default is not an acceptable practice“. So if one is defaulting on loan, he/she shall not accept a very polite handling of the issue.
But this is only one side of the matter.
People who are stuck due to genuine problems, must also remember that “even the loan defaulters has their rights“. Banks cannot simply send recovery agent at their doors to shake them up and show disrespect.
Rights of Loan Defaulters
In this article we will see what are the rights of loan defaulters.
There are RBI’s rules, which all banks must adhere to in handling cases of loan default. This is specially true for handling cases dealing with common men defaulting in small loan like credit card debt, personal loan, home loans etc.
Genuine Loan Defaulter
What Banks can do for genuine loan defaulters? There are rules, and bank’s would do everything within those rules to assist the loan defaulter.
But why banks will help a defaulter? Because it is also in their interest to not allow a loan to convert into an NPA. So what a defaulters should do is to approach the bank proactively and explain them the problem.
As per banking rules, these are the few ways in which banks can help a loan defaulter. In these cases the bank will follow the rules specified as per SARFAESI Act.
- LOWER THE EMI: Banks can lower the EMI in two ways: (a) by increasing the loan tenure, (b) by converting non-secured loan to a secured loan. In banking terms it is called as loan rescheduling of restructuring. Lowering of EMI’s due to tenure extension may help few defaulters. But as per bank rules, tenure cannot be increased a lot. As a result, the net effect on EMI reduction is very nominal. But in case of non-secured loan (like personal loan) being converted into a secured loan, reduction in EMI is appreciable. Read more about whether to reduce EMI or tenure in loan prepayment.
- ALLOW EMI FREE PERIOD: In cases where the flow of income has been temporarily disturbed, this type of relief may help the borrower. Unforeseen issues like job loss, temporary stoppage in business, operation etc, can be addressed this way. Here the banks may agree to waif-off the EMI collection for a certain period of time (say 3-6 months). After the lapse of this period, the EMI payment must start. Read moe about how home loan prepayment can save lakhs.
- ACCEPT A HAIR CUT: There can be a case, where the loan defaulter is in no condition to repay back the loan balance (today or in future). But he is offering to pay a part of the loan. In return for this part-payment, the defaulter is asking the bank to close the loan once and for all. Why a bank should agree for such an offer? Because it is better to get something than nothing. Here the onus is on the loan defaulter to convince the bank to accept the offer. Read more about what it means for banks to ‘take a hair cut’.
- FOLLOW SARFAESI ACT: Bank’s will resort to this step only when a loan has been deemed as an NPA. It means, the above three steps has failed. What is SARFAESI Act? The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act. As per SARFAESI Act, banks etc can arrange for recovery of their NPA’s without the need to move to the Court of Law.
We will read more about the SARFAESI act in the latter part of this article (see “just unable to pay the loan” below).
What we have seen now, was what best banks can do for the “genuine” loan defaulters.
But the treatment is not the same for other people.
Loan Recovery Agents
Recovery agents are meant for people who are acting smart. These are loan defaulters who have missed their EMI’s, and are avoiding the bank.
In these cases, Bank use the recovery agents to bring the loan defaulter to the negotiation table. But there are few guidelines of RBI regarding the role of recovery agents.
In the past, in one of the publications of Reserve Bank of India (RBI) it was mentioned that:
“…engagement of recovery agents is causing serious reputation risk for the banking sector as a whole…”.
Taking a corrective action, RBI revised the guidelines for engaging recovery agent by banks.
There is a clear cut guidelines from RBI that, banks/recovery agents cannot use ‘uncivilised, unlawful and questionable behaviour’ in the process of loan recovery.
What are the guidelines?
- Hiring of professional recovery agents: Banks must do due diligence on the agency before hiring them as a recovery agent. Due diligence shall not only look at the company as a whole, but must also look at people who are involved in the recovery process. The person hired as recovery agents shall pass through police verification. The family background of person in consideration shall also be checked by the agency before hiring. So it means that, if a rowdy (in name of recovery agent) misbehaves, a police complaint can be lodged in the police station. In this case the bank/recovery agency must give clarification on the behaviour of agent with the defaulter. Unsatisfactory reply may result in loss of contract of the recovery agency. Unlawful conduct of the recovery agents with the defaulter is a criminal offence.
- First send notices, then recovery agents: Before bank sends a recovery agent, they must issue intimations. In the intimation letter they must first authorise a recovery agency to act on their behalf. Communication of authorisation shall go to the loan defaulter directly from the bank. In case no intimation has been sent, load defaulter can refuse to hear the agents. Recovery agent may self carry the authorisation letter, but this is applicable if past attempts to deliver the letter has failed. Recovery must show the authorisation letter and identity card. In case the agents misbehave, the details of identity card can be used to lodge a police complaint. Bank must also publish the details of recovery agency on their website.
- Hear the case of the loan defaulter: Banks must hear the defaulters side of story without a bias. Banks must also issue one more communication to the defaulter. This communication should furnish details of ‘how and to whom’ the loan defaulter can contact in the bank, explaining his grievances. The loan defaulter can then show a copy of discussion with bank, in case the recovery agents further disturbs them.
- Recovery agents are Bank’s responsibility: Frankly speaking, it is banks job to undertake loan recovery process in case of default. But RBI has allowed banks to offload the recovery process to a third party. But there are risks when a banking activity is offloaded to a third party. In order to manage the risks, RBI asked banks to provide training to new recovery agents. All recovery agent shall first get a certification, and only then they can act as recovery agents. The training session must explain the “code of conduct & protocol” that recovery agents should practice while dealing with the loan defaulters.
Just unable to pay the loan..
What banks can do when a person is just not able to payback the loan?
In case of personal loan, bank has no collateral. Hence personal loans are called as non-secured loans. In case of personal loan default, banks has only few options:
- Negotiations: The best bet for banks is to sit on a negotiation table with the defaulter and settle the litigation. This is the most preferred options even for the banks. Why? Because in litigations banks will have to further expend money on the NPA.
- Use of Post Dated Cheques: But if the negotiations fail, the bank may decide to go to court. But as loan default is a civil dispute, arrest cannot be made. Hence what bank may do it to present the post dated cheques for clearing. If the cheques get bounced, then as per rules, arrest can be made.
In case of secured loans like (Auto, home loan etc), banks can do the following:
- Issue Notice: The bank will first declare your loan as an NPA. When a loan becomes NPA? When dues are not paid for more than 90 days. After this, bank will have to issue you a ’60 day notice’ under SARFAESI Act. In this notice period, the loan defaulter can payback the dues and close the case.
- Issue Public Notice: In case of Auto loan, the collateral will be like car, bike etc. In case of home loan, collateral will be a residential property. If loan is not cleared within the 60 day notice, bank will issue a 30 day public notice informing about the sale of asset.
- Issue Fair Value Notice: Before the asset is sold, the bank must also issue a notice informing about the fair value of asset that is going to be sold (in the public auction etc).
- Seize The Collateral: After notice period is served, the bank can immediately seize the collateral (asset), and initiate its sale proceedings.
What the borrower (loan defaulter) can do here? Not much. But if the defaulter thinks that ‘property seizure’ or ‘property fair value’ has not been handled properly, they can raise the objection in written to the bank. The bank is obliged to reply within 7 days. But after the reply, the bank can go ahead and sell the asset as per the public notice issued.
One must appreciate the fact that, Banks/Government cannot be lenient towards the loan defaulters. If they are lenient in one case, then it will be taken as precedence. People will start taking loan default as an excusable crime.
It is essential for a borrower to understand that availing loan is a very serious step in ones life. One must think 100 times before getting into debt. All pros and cons must be studied by the borrow before taking even a penny of loan.
Taking loan is a risk. If loan is small, risk is less. If loan is big, risk is more.
The point is, a borrower must deliberate the consequences of loan defaulting before getting into the loan.
Read more about how to get out of debt faster.