Defaulting on a bank loan: Can an individual borrower be jailed? Know the legal and financial risks

We often hear about large business groups defaulting on loans worth thousands of crores. But what happens when an individual borrower stops repaying a bank loan?

Here’s what experts say about what happens legally and financially if you don’t repay a loan.

When does a missed EMI become a default?

Mukesh Chand, Senior Counsel at Economic Laws Practice, explained that this is governed by the terms of the loan agreement. A default usually means failure to pay an instalment on its due date. Therefore, even a one-day delay in EMI can be considered a default.

Malak Bhatt, Chamber Head at Chambers of Malak Bhatt, said that a loan account is classified as a non-performing asset (NPA) when dues remain overdue for more than 90 days. A secured lender may then issue a notice under Section 13(2) of the SARFAESI Act, 2002 and enforce the security after 60 days, or approach the Debts Recovery Tribunal (DRT).

What counts as default on an unsecured loan?

Chand said a default occurs when a borrower fails to repay the loan dues or instalments on their due dates.

“Bankruptcy, under the Insolvency and Bankruptcy Code, 2016, is a separate status that may arise when the borrower fails to repay the debt and cannot provide an acceptable repayment plan, or when creditors reject the proposed plan,” he noted.

How much can you borrow without collateral?

Bhatt said there is no statutory ceiling. Unsecured lending limits are fixed by each lender's board-approved credit policy, assessed against income, repayment capacity, existing obligations, and credit bureau score.

Can a bank recover the loan amount from your other assets?

Yes. “Once a lender obtains a decree from a civil court or a recovery certificate from the Debts Recovery Tribunal, it may attach and sell the borrower's other assets in execution,” Bhatt explained.

However, Chand noted that the recovery could also be effected against the other assets which stand in the name of the borrower, except those protected by law, such as essential household items, certain residential property, pensions, provident funds, retirement benefits, and life insurance proceeds.

Is the borrower’s family liable for the loan?

No. According to Chand, only the guarantor is liable to repay the loan, as the guarantor's liability is co-extensive with that of the borrower. Family members are not liable for the loan if they have not provided a guarantee.

Can you settle a loan for a lower amount?

Bhatt said a borrower can seek a compromise or one-time settlement (OTS) under the lender's board-approved policy, based on the Reserve Bank's Framework for Compromise Settlements and Technical Write-offs.

He added that the borrower can make a proposal, after which the lender assesses recoverability and the amount it may have to forgo. If approved, a lump-sum or staggered payment can be made.

Chand added that a borrower cannot claim settlement of a loan at a lower amount as a matter of right. However, depending on the loan type, reasons for default and the borrower's financial position, the bank may also consider restructuring, particularly for a viable business loan, or an OTS/compromise settlement.

Can loan default lead to imprisonment?

Bhatt explained that “default attracts penal charges, a lower credit score, and possible classification as a wilful defaulter, which restricts access to fresh credit”.

Default by itself is a civil wrong and not an offence, and no person may be imprisoned merely for inability to pay. He said criminal liability may arise only in specific situations, such as cheque dishonour or cheating, where dishonest intention existed at inception.

What happens to a secured asset if the borrower defaults?

Bhatt said a lender may take possession of and sell a mortgaged asset under Section 13(4) of the SARFAESI Act, 2002, after the 60-day notice period and following the prescribed valuation and sale process. The borrower retains the right to redeem the asset until publication of the sale notice.

Chand said that in secured loans such as home or car loans, if the sale proceeds are not enough to clear the outstanding loan, the borrower remains liable for the shortfall.

Disclaimer: This is only for informational and educational purposes. Please consult a qualified expert for the latest laws and regulations.