A loan becomes a nonaccrual loan when you have not made a payment in at least 90 days. After 90 days, it is considered a non-performing loan and enters into nonaccrual status. As a result, the loan stops accruing interest, and the lender does not earn any revenue on it.
Many loans in default can become nonaccrual loans. Exceptions include consumer loans, Federal Housing Administration (FHA) loans, and those adequately secured by collateral and in the process of collections.
Both banks and borrowers want to avoid nonaccrual loans, so it is important to understand how nonaccrual loans work. Find out what happens if your loan is put on nonaccrual status and what you can do to get it reinstated.
Definition and Examples of a Nonaccrual Loan
A loan turns into a nonaccrual loan when a principal or interest payment is overdue by 90 days or more or when full payment of principal or interest is not expected.
- Alternate names: doubtful loans, troubled loans, sour loans
Usually, the lender puts it on a cash basis and can no longer add interest to the loan, thereby losing revenue. At this point, the loan is classified as non-performing and has been reported to the top credit reporting bureaus.
Nonaccrual loans include mortgage, bank, commercial and industrial loans. In addition, leases, debt securities, and other assets can enter into nonaccrual status.
Here’s an example of a nonaccrual loan. Let’s say you default on a mortgage loan by more than 90 days and have no collateral to secure it. The bank will move the loan to nonaccrual status and report it. Because payment history is part of what makes up your credit score, this will likely have a negative impact on your credit score.
How a Nonaccrual Loan Works
Lenders use guidelines outlined by the Federal Deposit Insurance Corporation (FDIC) and the Federal Financial Institutions Examination Council (FFIEC) to determine when an asset needs to be reported as entering a nonaccrual status.
A lender will put a loan on nonaccrual status if it meets one of the following criteria:
- The bank decides to maintain the loan on a cash basis because of the deterioration in the borrower’s financial condition.
- Payment in full of principal or interest is not expected.
- Principal or interest has been in default for 90 days or more unless the asset is well secured and in the collections process.
The FDIC defines a well-secured asset as collateral backed by a lien on or pledge of real or personal property that adequately covers the debt or is guaranteed by a financially responsible party.
Placing a loan into nonaccrual status allows lenders to identify losses and evaluate the borrower’s financial situation to determine the likelihood of repayment.
While reaching a nonaccrual status is unfavorable for both banks and borrowers, it is possible to reverse.
For example, suppose your mortgage loan enters nonaccrual status. In that case, the bank may review your financial history and agree to a troubled debt restructuring (TDR) as a way for you to repay the debt.
A TDR can modify and renegotiate loan terms so that you can make payments and eventually return the loan to accrual status. The TDR may reduce the principal balance, lower interest rates, or extend the loan’s maturity date.
Requirements for Nonaccrual Loan Reinstatement
Banks are willing to work with borrowers to restore a loan or asset to accrual status. Whether it’s through a TDR, another payment arrangement, or restructuring, a nonaccrual loan must meet one of the following requirements to be reinstated to accrual status:
- The bank must have received all past-due principal and interest, and expects to receive repayment of the remaining contractual principal and interest.
The loan becomes well secured through collateral or personal guarantee and is in the process of collections.
- The loan isn’t current yet, but the borrower has resumed paying the full contractual principal and interest payments for at least six months. As a result, the bank has reasonable repayment assurance.
Every borrower and loan contract is different. The likelihood of repayment and restoration of accrual status depends on a variety of factors, including the lender’s policies, a financial evaluation of the borrower, the borrower’s sustained repayment performance, and the restructuring agreement.
- A nonaccrual loan has a past-due payment of 90 days or more.
- Nonaccrual loans don’t earn interest or generate revenue for lenders.
- You can reinstate nonaccrual loans through troubled debt restructuring or other repayment plans.
- Nonaccrual loans can negatively impact your credit score and may affect you in the future if you need another loan.