Study on Credit Default Rate: Historical vs- Post-COVID3 min read

linkedin-sales-navigator-nysVe5rsJtc-unsplash
Share on facebook
Share on twitter
Share on linkedin
Share on email

Executive Summary

Business loans can provide business owners with a much-needed capital boost. The COVID-19 pandemic has placed unprecedented economic strain on many businesses and individuals. With revenues drastically falling during this period, many are struggling to meet financial commitments or even keep their business afloat. For business owners, it is crucial to understand the meaning of default rates, the long-term effects of a default on businesses, and how default differs from delinquency.

What is the default rate?

The default rate is the percentage of all outstanding loans that a lender has written off as unpaid after a prolonged period of missed payments. The default rate is also known as the penalty rate. 

For every loan you take from a bank, the loan agreement will spell out its terms. This includes the value of collateral involved, principal repayments, interest rates, tenure of repayment, and default terms. The time period of non-payment before a loan is deemed in default usually depends on the loan type and amount. 

Typically, lenders wait 90 to 120 days before they consider a loan to be in default. Defaulted loans are typically written off as bad debt in the bank’s financial statements and eventually handed over to a debt collection agency. 

What happens when you default on a loan?

Once your loan goes into default, the lender will contact you to claim the overdue payments. If the period of non-payments prolongs, the lender’s methods will become more persistent. For business owners, here are some repercussions of defaulting on a loan agreement.

  • Your credit score will take a hit

Each missed payment will be reported to the credit bureau which will negatively impact your credit score. As your credit score suffers, you will face greater trouble in trying to secure loans or other forms of credit in the future. Late payments remain on your credit report for up to seven years. 

  • Debt collection and legal claims

Once your account is in default, it may be handed over to a debt collection agency to continue pursuing your repayment. If matters escalate, the lender may take legal settlement for the debt amount or liquidate any collateral you’ve pledged for the loan. Legal claims can be costly and tedious to handle.

  • Higher expenses

As a penalty, late payment fees will kick in once a loan is in default. Moreover, a weakened credit score may also result in higher interest rates for any future loans. 

How is delinquency different from default?

Delinquency refers to the period between missing a loan repayment and having the loan default. A loan becomes delinquent as soon as you’re late on a payment, by even one day. If you miss several payments or can’t make payments for an extended time (usually 90 to 120 days), the lender will place the loan in default and can start collection proceedings against you. 

Both delinquencies and defaults damage your credit. Your loan goes from delinquent status into default when you have an outstanding balance for a long period of time. Your loan agreement will specify exactly how long that is.

What is the loan default rate for small businesses?

Small businesses make up for almost half of U.S. private-sector employment and play key roles in local communities. The COVID-19 pandemic threatens the survival of many small businesses. The Federal Reserve acknowledges that the widespread failure of small businesses would adversely alter the economic landscape of local communities and potentially slow the economic recovery and future labor productivity growth. 

For the first quarter of 2020, Federal Reserve data shows that 1.12% of borrowers defaulted on commercial and industrial loans. In contrast, 2.47% of consumer loans went into defaults. Due to the higher qualification criteria set by lenders for business loans, there are typically fewer defaults as compared to consumer loans. 

In the corresponding period in 2019, there were 1.13% of defaults on commercial and industrial loans and 2.33% of consumer loans, which is not far off from the latest period data. Although the percentage of defaults for the first quarter of 2020 does not indicate a cause for alarm yet, subsequent data may reflect aggravated conditions. 

Since loan defaults can cause your credit score to deteriorate and negatively impact your business, it is advisable to contact your loan issuer right away to assess your options. Your lender may be open to discussing an alternative payment plan with smaller installments for the time being. 

About the author

You may also like

tillful white logo

Better your financial future.

Still have questions?

Subscribe Now!

Get FREE expert advice delivered to your inbox each week.

tillful app user interface