What happens if you default on a personal loan? Key financial and legal consequences explained

Personal loans have become an increasingly popular financial instrument. However, defaulting on a personal loan can result in severe consequences for borrowers. It's imperative to understand the outcomes of failing to repay a personal loan for good personal finance practices.

Below are some important points that should be kept in mind when a borrower is aiming to raise a personal loan to avoid the harsh consequences of not paying it on time.

1. Impact on credit score

Defaulting on a personal loan can immediately harm the borrower's credit score. Indian credit scores are between 300 and 900, and defaulting can lead to enormous drops.

A poor credit score complicates future borrowing and compels new loans to be at a greater rate of interest. As per rules set out by the Reserve Bank of India (RBI), if there is even a single payment default, then it can be reported to the credit bureaus, where it will stay for seven years.

2. Legal ramifications

In case of a default on personal loan, lenders can take the borrowers to court by filing a civil case, which would result in court directions for recovery. Loans are classified as Non-Performing Assets (NPAs) only if they are overdue for more than 90 days. When this happens, lenders step up recovery efforts, which may include seizing assets as per legal provisions. While loan default is a civil offense, there are legal measures that can make things difficult for defaulters.

3. Economic fines and penalties

Economic fines and penalties are imposed on borrowers in a variety of ways for failure to repay loan installments, such as delayed payment charges and premium interest on late payments.

These fines and penalties depend on the initial contractual obligations the borrower entered into with the loan disbursing financial institution. Interest on interest and surcharges increase repayment costs, making it even harder for borrowers to afford their loan installments.

4. Collection agency harassment

Where attempts at loan recovery prove to be futile, the lenders can hire the services of debt collection agents, who can harass and threaten the borrowers. It can be a harrowing experience, thus making it important for the borrowers to convey difficulty in repayment to lenders openly.

5. Lower eligibility for loans

Missing a personal loan repayment will negatively impact future borrowing and credit cards availability. Banks and financial institutions consider the repayment track record of the borrower, and if it is not good, the loan is not approved, or the loan terms are not lenient and might come with fairly high interest rates, higher processing fees, and limited flexibility in repayment terms. Borrowers will also find it hard to have credit cards or other credit instruments.

6. Effect on guarantors and co-signers

In the event of the loan being guaranteed or co-signed, it would force the guarantor and co-signers to meet the shortfall as per the initial contract of the personal loan agreement. This may impact the credit history and reputation of both the borrower and co-signers, and result in discrediting personal as well as professional relationships.

Conclusion

While it is a given that personal loans usher in instant funds, the threat of default is also always present until the loan is repaid. That is why borrowers should adopt caution before taking a loan and keep means of communication with lenders open in order to neutralise financial woes effectively.

(Note: Raising a loan comes with its own risks. So, due caution is advised.