Nonaccrual loans are loan agreements classified by lenders where no interest is being generated due to non-payment by the borrower for 90 days or more. Such loans fall into a category known as nonperforming loans (NPL).
Loans accrue interest as a portion of payments are applied to both the interest and the principal. When no interest has been paid over a period, the expected interest does not accrue, leading to a nonaccrual status. Common terms for nonaccrual loans include doubtful loans, troubled loans, or sour loans.
Key Takeaways
- Loans with no payments for 90 days are categorized as nonaccrual loans by lending institutions.
- The lender does not accrue expected interest income due to unpaid interest from the borrower.
- Borrowers can negotiate repayment plans to restore the loan to its previous status.
How Does a Nonaccrual Loan Work?
After 90 days of no payments, a loan becomes nonaccrual. It is then classified as substandard by the bank and reported to credit reporting agencies, impacting the borrower’s credit score.
To mitigate potential losses, lenders adjust their allowance for potential loan loss and set aside a reserve. Legal action could also be pursued against the borrower.
Lenders expect timely payments of principal and interest. When a loan turns nonaccrual, it shifts to a cash basis where interest is only recognized as income if, or when, it is eventually collected.
Assets are classified as nonaccrual if:
- They are handled on a cash basis due to the borrower’s deteriorating financial condition,
- Full repayment of principal or interest is not anticipated,
- Principal or interest payments are overdue for 90 days or more, unless the asset is both well-secured and in the process of collection.
A nonaccrued loan is deemed substandard, potentially leading to reports to credit agencies.
How to Return a Loan to Accrual Status
Borrowers in nonaccrual status can work with their lenders to establish a repayment plan.
For a loan to return to accrual status, the borrower might:
- Pay all overdue principal, interest, and fees and resume regular monthly payments.
- Continue the scheduled payments for six months while providing assurance that the debt will be paid off within a specific timeframe.
- Offer collateral, pay the remaining balance within 30 to 90 days, and resume monthly payments.
Troubled Debt Restructuring
Another recovery option is a troubled debt restructuring (TDR), which may involve erasing part of the loan’s principal, reducing interest rates, accepting interest-only payments, or altering the repayment terms in line with the borrower’s financial capabilities.
Can Any Loan Become Nonaccrual?
Most loans can be placed under nonaccrual status if they are 90 days past due, with exceptions being certain secured loans backed by valuable collateral. Upon default, a lending institution can recover funds by liquidating the collateral.
Requirements for Troubled Debt Restructurings (TDRs)
According to the Office of the Comptroller of the Currency (OCC), specific guidelines exist for establishing TDRs for nonaccrual loans. Borrowers experiencing financial challenges can work with lenders to determine if a TDR suits their situation.
Understanding Cash-Basis Loans
When a loan is on a cash basis, it indicates nonaccrual status. The absence of interest payments for 90 days prohibits lenders from recording it as accrued income; it must instead be documented on a cash basis.
Related Terms: Unsecured Loan, Nonperforming Loan, Interest, Principal, Collateral, Cash Basis Loan.
