What Is a Nonaccrual Loan?

A nonaccrual loan is a lender's term for an unsecured loan whose payment is 90 days or more overdue. The loan is no longer generating its stated interest rate because no payment has been made by the borrower. It is, therefore, a nonperforming loan.

Loans can have interest credited only when the borrower makes a payment (of a portion of the principal plus interest). The interest on a nonaccrual loan is thus recorded as earned income.

Nonaccrual loans are sometimes referred to as doubtful loans, troubled loans, or sour loans.

How a Nonaccrual Loan Works

A loan becomes a nonaccrual loan when no payment has been received after 90 days. The bank classifies the loan as substandard and reports the change to the credit reporting agencies, which lowers the borrower's credit score.

Key Takeaways

  • A lending institution categorizes an unsecured debt as a nonaccrual loan if no payment has been made for 90 days or more.
  • In accounting terms, the expected interest has not accrued to the lender because no interest has been paid by the customer.
  • A borrower can work out a repayment plan to restore the loan to its previous status.

The lender changes its allowance for the potential loan loss, sets aside a reserve to protect the bank's financial interests, and may take legal action against the borrower.

The loan is also put on a cash basis, meaning that interest is recorded as earned only if and when a payment is collected, not as an assumed payment. Ordinarily, interest income is accrued on loans, since regular payment of both principal and interest is assumed. 

According to the Federal Deposit Insurance Corp. (FDIC), an asset is to be reported as being in nonaccrual status if one of three criteria are met:

  • It is maintained on a cash basis because of 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 90 days or more unless the asset is both well secured and in the process of collection. 

A well-secured asset is one that is backed by collateral such as a lien, a pledge of real or personal property, or securities valuable enough to cover the debt, or is guaranteed by a financially responsible third party.

An unaccrued loan is classified as substandard and the borrower is reported to the credit agencies.

Restructuring a Nonaccrual Loan

After entering nonaccrual status, the borrower usually can work with the lender to determine a plan for paying off the debt. After reviewing the borrower's income and expense status, the lender may create a troubled debt restructure (TDR).

The TDR may erase part of the loan's principal or interest payments, lower the interest rate, allow interest-only payments, or modify the repayment terms in some other way. Lower debt payments may be accepted until the borrower's financial situation improves.

Returning a Loan to Accrual Status

A loan will be returned to accrual status if the borrower pays all the overdue principal, interest, and fees and resumes the regular monthly payments defined in the contract.

If both parties agree, another option involves resuming the scheduled principal and interest payments for six months and providing the lender reasonable reassurance that the outstanding principal, interest, and fees will be paid within a set period of time.

A third option requires the borrower to provide collateral for securing the loan to the lender, repaying the outstanding balance within 30 to 90 days, and resuming monthly payments.