Nonperforming loans are loans, especially mortgages, that organizations lend to borrowers but do not capitalize on. In other words, the borrower cannot pay the loan back in full, or even enough for the bank to make a profit. When this happens, the bank can either work out a new payment option, or foreclose on what collateral the borrower has provided. Either option costs the bank money, so lenders try to avoid nonperforming loans whenever possible.
Most nonperforming loans are caused by borrower decisions. Sometimes borrowers decide to qualify for loans without thinking enough about the future and what else they need to buy with their income. When this occurs, a credit culture can develop where borrowers take out large loans not because it is financially wise but because they see others doing it. That can easily result in defaulted loans.
Sudden Market Changes
Any sudden market change can change the loan market by affecting how much money people have to take out loans and make payments. If the market suddenly changes and the prices of objects increase due to shortages or greater demands, borrowers will have less money to pay off their loans, which can lead to greater overall nonperformance.
Real Estate Changes
The real estate industry and home loans--one of the staples of the loan industry--are closely connected. If prices in the real estate market fall--if houses sell for less and less--then lenders recoup less and less money from seizing properties in response to defaulted loans. This results in more loans becoming nonperforming, losing the lender money instead of making it.
Bank performance also acts as a key cause of nonperforming loans. An efficient and well-run bank should be able to adjust loan rates and terms to the current market in order to decrease the chance of nonperforming loans. Banks should also be selective as to which borrowers they accept. Banks that do poorly in these areas will create more nonperforming loans.