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What are Nonperforming Loans?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 13 September 2016
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Nonperforming loans are loans that are soon to be declared in default, or have already been declared in default. Loans of this type are considered nonperforming because the lender is no longer receiving a return on his or her investment, since the borrower is no longer paying on the principle or the interest that applies to the loan. While the criteria used to determine if a loan is nonperforming varies slightly, there are a few basic guidelines that are used by most banks and other types of lenders.

For many lenders, nonperforming loans are any loans where payments on the principal or the interest have not been received in the last ninety calendar days. At this point, lenders may choose to move the loan balance into a nonaccrual account, since no income is being generated from the loan. Changing the status of the debt to a nonaccrual loan helps to keep the income statement within proper balance.

There are other situations in which loans may be considered nonperforming. If a minimum of ninety days of payments have been delayed and refinanced by mutual agreement between the lender and the debtor, the status of the loan is considered nonperforming. Any loans in this category will remain classified as nonperforming loans until the payments are brought up to date in accordance with the refinancing.

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In addition, any loans where the payments are thirty to sixty days overdue, and the lender has good reason to believe no payments are forthcoming, may also be classified as nonperforming loans. For example, if the lender becomes aware that the debtor is about to file bankruptcy, and include the loan balance in the filing, that would be considered good enough reason to declare the loan a nonperforming asset. In the event that the courts eventually forward partial payment to the lender, those funds are entered into the accounting books as income, with that much of the balance transferred out of the nonaccrual account in order to balance with the receipt of the income.

Since there is some variance in how different financial institutions determine what does and does not constitute nonperforming loans, it is very important to look closely at the contract terms related to the loans issued by a specific lender, as well as the general policies and procedures of that lender. This will help borrowers know in advance what type of activity is likely to lead to declaring a loan to be nonperforming, as well as help borrowers understand what this can mean for their credit ratings.

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