What is an unclassified loan?
An unclassified loan is a bank loan that the lender considers to be at high risk of default.
If a bank thinks there is a high likelihood that a borrower will stop making payments on a loan, it can change the classification of the loan from unclassified to classified. Once a loan is classified, the bank can take steps to prepare for losses it expects to incur from the borrower’s non-payment.
The bank may decide to change a loan’s status from classified to unclassified if the borrower misses a payment. However, any change in the borrower’s circumstances can change the classification of a loan from unclassified to classified. Should the bank uncover new information about a borrower that indicates he or she is a higher risk than expected, this can also alter the loan’s status.
Classified loans frequently wind up costing the bank money and may increase the overall cost of borrowing for other bank customers.
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Unclassified loan example
The bank examiner makes the decision to leave a loan as unclassified or to change the status to classified. For example, if the examiner reviews a loan and sees that the creditor is up to date on payments and has not had a significant change in income or credit status, the examiner would leave the loan’s status as unclassified.
However, if the examiner sees that a borrower has stopped making payments and is currently 90 days past due, the examiner would designate the loan as classified. The bank labels the loan as an adversely classified asset on its balance sheet. In other words, the bank considers its chances of recovering its investment to be poor.
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