Nonperforming Loan (NPL)

What is a nonperforming loan (NPL)?

A nonperforming loan (NPL) is a loan on which the borrower has failed to make scheduled principal or interest payments for a specified period—commonly 90 to 180 days. Once classified as nonperforming, the loan is considered at heightened risk of default and can harm the borrower’s credit and a lender’s balance sheet.

Key takeaways

• NPLs are loans overdue long enough (typically 90–180 days) that repayment is uncertain.
• If payments resume, an NPL can become a reperforming loan (RPL).
• NPLs rise during economic downturns and can dent banks’ profitability and capital ratios.
• Banks often sell NPLs to investors at a discount rather than try to collect themselves.
• Consumer-debt collection is subject to legal restrictions on abusive practices (applicable to third-party collectors).

How NPLs work

• Arrears vs. default: A loan is in arrears when payments are late; it is in default when the lender determines the borrower has breached loan obligations and repayment is unlikely.
• Typical thresholds: Commercial loans are often classed as nonperforming after 90 days past due; consumer loans commonly use a 180‑day threshold.
• Reperformance: If a borrower catches up or resumes payments under a modified agreement, the loan may be classified as reperforming even if missed payments were not fully repaid.

Types and examples of NPLs

NPLs can arise in various ways, including:
* Loans with interest capitalized, refinanced, or delayed (e.g., 90 days’ interest added to principal).
* Loans less than a threshold past due but judged unlikely to be repaid.
* Loans past their maturity date with outstanding unpaid principal.

Example: A borrower loses a job and misses payments. After the lender waits the defined period (e.g., 90 days), the loan is classified as nonperforming. The lender may pursue collection, send the debt to a collection agency, sell it to a debt buyer at a discount, or negotiate a modification.

Official classification guidance

Regulators and international bodies set criteria to ensure consistent classification and provisioning:
* European Central Bank (ECB): Treats loans 90 days past due as nonperforming for supervisory assessments and links provisioning timelines to loan characteristics (secured vs. unsecured).
* International Monetary Fund (IMF): Uses similar criteria—nonpayment of principal or interest for 90 days or more, capitalization/refinancing of interest, or other indicators of high uncertainty about future payments.

Why NPLs increase

• Economic downturns, rising unemployment, and falling income reduce borrowers’ ability to pay.
• Sector-specific shocks (e.g., real estate, commodity prices) can produce concentrated NPLs.
• Poor underwriting or rapid credit growth can create structural weaknesses that later materialize as NPLs.

Consequences of NPLs

For borrowers:
* Damage to credit scores and higher borrowing costs.
* Possible loss of collateral through repossession in secured loans.

For lenders and the financial system:
* Reduced interest income and profitability.
* Increased provisioning requirements and pressure on capital ratios.
* Potential contagion effects if NPLs rise sharply across lenders or regions.

What lenders do with NPLs

• Collection efforts: In-house collections or use of third-party agencies (subject to consumer protection laws).
• Loan workouts: Modifications, forbearance, or restructuring to restore payments.
• Sale of loans: Banks often sell NPL portfolios to distressed-debt investors or other institutions at a discount.
• Enforcement: Repossession or foreclosure where collateral exists.

Who buys NPLs?

• Distressed-debt investors and special‑purpose funds.
• Other banks or financial institutions.
• Real estate investors (for loans secured by property).

Resolving an NPL as a borrower

• Repayment: Catching up on missed payments if possible.
• Loan modification: Adjusting interest rate, term, or principal to make payments affordable.
• Forbearance or temporary relief: Short-term pause or reduced payments.
• Debt settlement or forgiveness: Negotiated reductions in principal or interest (may harm credit).
• Bankruptcy: May restructure or discharge obligations depending on jurisdiction and case specifics.

Comparison: NPL vs. reperforming loan (RPL)

• NPL: Currently delinquent and classified as nonperforming.
• RPL: Previously nonperforming but returned to current payment status through cure, modification, or bankruptcy arrangement.

Conclusion

Nonperforming loans are loans with prolonged missed payments that signal higher likelihood of loss for lenders and credit consequences for borrowers. They tend to rise in economic stress and require active management—through collection, restructuring, sale, or enforcement—to mitigate losses and restore loan performance.