What Is the Difference Between Performing & Non-Performing Loans?

Lending is a basic financial activity that's vital to the performance of the modern economy. When individuals and businesses take out loans they pour the borrowed money back into the economy by purchasing things such as equipment, homes and cars, which drives economic output. However, if borrowers fail to make payments on their loans it can make lenders more hesitant to issue new loans, which can negatively affect the economy. "Performing" and "non-performing" are terms that describe whether a loan is in default.

A performing loan is a debt on which the borrower has historically made payments on time. For example, if a homeowner takes out a mortgage and pays his home loan faithfully each month, his mortgage is considered a performing loan. In some cases, loans in which payments are less than 90 days late may be considered performing.

A non-performing loan is a debt on which the borrower is late on making payments or is in danger of missing payments. Loans where the borrower is 90 days late on payments are considered non-performing, but any loan in default or near default may also be called non-performing. Lenders take a variety of steps to avoid and mitigate the impact of non-performing loans, such as denying loans to especially risky borrowers and charging higher interest rates to borrowers with lower credit scores.

Subprime lending describes loans made to risky borrowers who carry high interest rates. In theory, the high interest rates of subprime loans makes up for the risk that some borrowers will fall into default. Subprime loans tend to have a high chance of becoming non-performing, both because they're typically made to risky borrowers and because they involve higher interest rates, which makes them more costly and therefore more difficult for borrowers to pay back.

Subprime lending was one of the major contributors to the financial collapse and recession that began in the late 2000s. During the late 1990s and into the 2000s many banks made risky subprime loans. When large numbers of those loans went into default the banks were forced to foreclose on huge numbers of homes and absorb large financial losses. In other words, non-performing loans became one of the causes of the recession.