Legal Definitions - nonperforming loan

A nonperforming loan is a loan where the borrower has failed to make scheduled payments of principal and/or interest for a significant period, typically 90 days or more. At this point, the lender considers it highly unlikely that the borrower will be able to repay the loan in full without taking further action, such as restructuring the loan or pursuing collection efforts. These loans are considered impaired assets on a lender's balance sheet because they are no longer generating income and carry a high risk of default.

Here are some examples to illustrate this concept:

• Example 1: Residential Mortgage
  A homeowner loses their job unexpectedly and, despite their best efforts, is unable to make their monthly mortgage payments for four consecutive months. The bank has attempted to contact them but has not received payment.

  How it illustrates the term: This mortgage would be classified as a nonperforming loan because the borrower has consistently failed to meet their payment obligations for an extended period, indicating a high risk of default for the lending institution.

• Example 2: Small Business Loan
  A small manufacturing company takes out a loan to purchase new equipment. However, a sudden downturn in their industry causes a sharp decline in orders, making it impossible for the company to generate enough revenue to cover its monthly loan installments for over three months.

  How it illustrates the term: The business loan becomes nonperforming because the company is no longer making its required payments, signaling to the bank that the loan is in jeopardy and unlikely to be repaid under the original terms.

• Example 3: Auto Loan
  An individual finances a new car, but due to a serious illness and mounting medical bills, they are forced to prioritize other expenses and stop making their car loan payments for five months.

  How it illustrates the term: This auto loan is now considered nonperforming. The borrower's consistent failure to make payments means the lender is not receiving the expected income from the loan and faces a significant risk of loss, potentially leading to repossession of the vehicle.