What Is a Nonaccrual Loan and How it Works

Anbarasan Appavu

What Is a Nonaccrual Loan?

Accounting professionals in the financial sector use the term "nonaccrual loan" to refer to an unsecured loan that is no longer accruing interest at the rate that was originally agreed upon because the borrower has not made a payment on the loan in at least 90 days. It is now considered a nonperforming loan, which means the lender will not receive any interest on it (NPL).

Interest is only accrued on loans when the borrower makes a payment, of which some of the payment goes toward paying the interest and the rest goes toward paying off the principal. The interest that is collected on loans is counted as revenue for the lender. If the borrower has not made any interest payments, the loan is considered to be nonaccrual because the anticipated interest has not been accumulated.

Loans that do not accrue interest are sometimes referred to as questionable loans, troubled loans, or sour loans.

In accounting terms, the anticipated interest has not accrued to the lender because the customer has not paid any interest on the loan. A borrower can work out a repayment plan to return the loan to its previous status and begin accruing interest again. An unsecured debt is considered a nonaccrual loan if no payment has been made for at least ninety days.

How a Nonaccrual Loan Works

A loan is considered nonaccrual after it has gone more than 90 days without being paid back. The borrower's credit score will drop because the bank will report the loan's status as substandard to the credit reporting agencies. This will have the effect of lowering the borrower's credit score.

In addition to this, the lender adjusts its allowance for the potential loss on the loan, establishes a reserve to protect the bank's financial interests, and may even take legal action against the borrower.

The assumption of interest income from loans is common practice because the lender anticipates receiving regular payment of both the principal and the interest on the loan. When a loan stops accruing interest, it is placed on a cash basis because the interest is no longer treated as an assumed payment for the loan. Only in the event that payment is eventually collected will interest begin to be recorded as income once more.

An asset should be reported as being in nonaccrual status if one of the following three criteria is met, as stated by the Federal Deposit Insurance Corporation (FDIC):

• It is maintained on a cash basis due to a deterioration in the financial condition of the borrower;

• Payment in full of principal or interest is not expected; or

• Principal or interest has been in default for ninety days or more, unless the asset is both secure and in the process of collection. (An asset is considered to be well-secured when it is either backed by collateral, such as a lien or a pledge of real or personal property, or securities that are valuable enough to cover the debt, or when it is guaranteed by a financially responsible third party.)

When interest is not accrued on a loan, the loan is considered delinquent, and the borrower's information is sent to credit reporting agencies.

Returning a Loan to Accrual Status

After changing the borrower's status to nonaccrual, the lender will typically work with the borrower to devise a strategy for paying off the outstanding debt.

For instance, the status of a loan can be changed from deferred to accrue if the borrower makes up any missed payments on principal, interest, or fees and then resumes making the standard monthly payments as outlined in the contract.

Resuming the regularly scheduled payments of principal and interest for a period of six months while assuring the lender, to the best of one's ability, that all outstanding payments of principal, interest, and fees will be made within the agreed-upon time frame is yet another alternative that can be pursued, but only if both parties are in agreement.

The borrower is required to provide the lender with collateral in order to secure the loan, the outstanding balance must be repaid within thirty to ninety days, and monthly payments must be resumed in order to proceed with the third option.

Troubled Debt Restructuring

Following an analysis of the borrower's current situation regarding their income and expenses, the lender also has the option of establishing a troubled debt restructuring (TDR). The TDR could wipe out a portion of the loan's principal or interest payments, reduce the interest rate, and make it possible to make interest-only payments, or alter the terms of repayment in another manner. Until the borrower's financial situation improves, the lender might agree to accept lower debt payments from them.

Is It Possible for Any Loan to Become Non-Accrual?

If payments on almost any loan are more than 90 days late, lenders have the ability to convert the loan into a nonaccrual status. The only exception to this rule is secured loans that are backed by substantial collateral (e.g., a mortgage backed by a house). In the event that a secured loan goes into default, the lending institution has the legal right to seize the collateral and sell it in order to recoup any funds that are owed on the loan.

What Are the Prerequisites for Troubled Debt Restructurings Known as TDRs?

The Office of the Comptroller of the Currency (OCC) provides lenders who are interested in establishing troubled debt restructurings (TDRs) for nonaccrual loans with a list of the requirements that must be met in terms of accounting and reporting. When a borrower is having trouble making their loan payments, they can work with their lender to determine whether or not a TDR is the best option for them.

What Does Cash-Basis Loan Mean?

If the lending organization is operating on a cash basis, this indicates that they have placed the loan in a nonaccrual status. Because the lender has not received the interest for at least 90 days, they are required to record it using the cash basis rather than the accrued income method because they are unable to record it as having been earned.


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