What happens if you default on a personal loan repayment? Know the consequences
Defaulting on a personal loan repayment can lead to financial, legal, and psychological consequences. Let us understand them in detail.
Late payment charges: Most banks collect the personal loan EMI through an auto-debit from the borrower's savings account. If the payment is returned, the bank will levy a payment return charge. For example, HDFC Bank levies a payment return charge of Rs. 450 per instance. Similarly, ICICI Bank levies Rs. 500 for cheque/auto-debit/electronic clearing service (ECS) bounce charges.
Apart from the payment return charge, there will be a delayed instalment payment charge. For example, HDFC Bank charges 1.50% per month (18% per annum) plus taxes on the overdue instalment amount. The bank provides a grace period of 7 calendar days from the instalment due date. After the expiry of the grace period, if the instalment remains unpaid, the delayed instalment payment charge is levied.
Similarly, ICICI Bank levies a late payment charge of 5% per annum on the overdue personal loan EMI until repayment.
Credit score takes a hit: As per RBI guidelines, banks must report all delays in personal loan EMI payments to the Credit Information Companies (CICs) like CRIF High Mark. The reporting is done every 15 days. Any delay in the personal loan EMI payment will reflect in the borrower's credit report. Timely payment of loan EMIs and credit card outstanding has the highest weightage in the calculation of an individual's credit score.
Hence, any delay in the personal loan EMI will hit the borrower's credit score badly. The borrower's credit score will fall sharply. After the EMI payment delay gets reported to the CICs, even if the borrower starts making EMI payments regularly on time, the recovery in the credit score will only be gradual.
Calls and visits from recovery agents: In the event of a personal loan EMI default, the bank will send you payment reminders through various channels like phone calls, SMS, emails, WhatsApp messages, etc. If the borrower doesn't pay up within a specified timeline, the case is handed over to the recovery department/agency. The recovery agents will start making calls and visits to the borrower's home/office, which can be embarrassing.
Co-applicant/guarantor will be asked to pay up: If there is a co-applicant or a guarantor, the bank will ask them to pay up on behalf of the borrower. If the borrower doesn't pay, the co-applicant/guarantor, if any, has the legal obligation to pay. If the co-applicant/guarantor doesn't pay, it will be reported to the credit bureaus. As a result, their credit score will take a hit.
Legal action: In spite of repeated reminders, if the borrower doesn't pay, the bank will initiate legal action by sending a legal notice. If there is a co-applicant/guarantor, they will also be sent a legal notice. If there is no response to the legal notice, the bank will file a recovery case against the borrower.
Getting new credit will be difficult: Once a personal loan default is reported to the CICs, it will stay there in the borrower's credit report for years, unless the borrower takes corrective action. It will make it difficult for the borrower to get any new loans or credit cards. Even if a bank decides to give a loan to the borrower, it may charge a higher interest rate. Some banks may insist on collateral as a risk mitigation measure.
If you are facing financial difficulty, and are unable to repay the personal loan EMI, you may communicate the same to the bank. Check with the bank if it can offer you temporary relief in the form of a moratorium for a brief period.
The other option is to ask the bank to restructure the personal loan and increase the loan tenure so that the EMI amount decreases. The lower EMI amount can reduce the financial burden during a financial crisis, till it is overcome.
When you take a personal loan, right from the beginning, you can take the following proactive steps.
Manage an emergency fund: You must always maintain an emergency fund to handle any unexpected or unplanned medical or other financial emergencies. In a particular month, if you are unable to pay the personal loan EMI due to any financial issue, you can dip into the emergency fund to pay the EMI. However, make sure to replenish the emergency fund, once the emergency is taken care of.
Maintain some extra amount in the savings account: As a precautionary measure, you can maintain some extra money in the savings account from which your personal loan EMI is debited. The extra amount can be equivalent to one to two EMIs. The extra amount will come in handy if you are not left with sufficient or any money in a particular month to pay the personal loan EMI. In such a month, the extra money maintained in the savings account can be used to pay the personal loan EMI.
Uncertain and unexpected events like a job loss, salary cut, salary delay, or any other event can lead to a financial drain. While you cannot prevent these events from occurring, you can be prepared to cushion their financial impact. During such events, you can fall back on your buffers like an emergency fund to pay for your regular expenses, personal loan and other loan EMIs, and sail through till the event passes.
A personal loan EMI default is a major event and has far-reaching financial, legal, and psychological consequences. Hence, it is best to be prepared with buffers, so that you can use them during financial uncertainties to prevent a personal loan payment default.
Gopal Gidwani is a freelance personal finance content writer with 15+ years of experience. He can be reached at LinkedIn.
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